10 Minutes with Marcus: Navigating Your Business's Balance Sheet
Written By Marcus Crigler | BEC CFO & CPA
Overview
As an entrepreneur, it's easy to get caught up in analyzing the profit and loss statement (PNL) and ensuring your business is making a profit. While profitability is essential, it's equally important to pay attention to your balance sheet. The balance sheet reveals how much you're keeping, not just how much you're making.
Strengthen Your Business with a Balanced Balance Sheet
One common question that arises is how much money you should keep in your business and what level of debt is appropriate. The answers to these questions lie in your balance sheet. It's crucial to understand that there is no one-size-fits-all approach. You need to assess your balance sheet to determine how to strengthen your business effectively.
Liquidity metrics play a vital role in evaluating your financial position. By examining your balance sheet, you can assess your ability to pay off debt that is due within the next 12 months. This includes analyzing your current liquidity and determining if you can meet your current debt obligations. Neglecting liquidity metrics can leave you vulnerable when unexpected financial challenges arise.
Another aspect to consider is the return on the money invested in your business. The balance sheet provides insights into this aspect, allowing you to gauge the healthiness of your returns. It's important to identify what constitutes a healthy return and when it may be necessary to change course.
Furthermore, your inventory and associated loans are significant components of your balance sheet. Understanding the details and implications of these entries is crucial for making informed decisions. Double-sided accounting emphasizes that accurate balance sheet numbers are essential to maintain accurate financial statements overall. By ensuring the accuracy of your balance sheet, you can avoid analyzing incorrect data on your PNL.
To get started, follow these simple steps:
Pull your balance sheet directly from your accounting system, such as QuickBooks Online or any other software you use.
Analyze three key numbers: the current ratio, the debt-to-equity ratio, and the return on equity. These metrics provide valuable insights into your financial health.
The current ratio, calculated by dividing current assets by current liabilities, helps determine if you have enough assets to cover short-term liabilities. Aim for a minimum ratio of 1.10, but ideally, target 1.25 to 1.5 for stronger liquidity.
The debt-to-equity ratio indicates the proportion of debt to equity in your business. It helps assess your leverage and financial risk.
The return on equity measures how effectively your business is using invested capital to generate profits.
By following these steps and regularly reviewing your balance sheet, you can gain a comprehensive understanding of your business's financial health. Strengthening your balance sheet ultimately contributes to the long-term stability and success of your company.
Remember, while the PNL provides valuable insights into your business's profitability, the balance sheet reveals how much you're retaining and the overall strength of your financial position. So, don't overlook the importance of focusing on the balance sheet—it's a key aspect of building a robust and resilient business.
