Are you focusing all your energy on your Profit and Loss account? While driving up revenue and driving down costs are important, a strong Balance Sheet is equally important. Even profitable businesses can, and do, go broke without a solid foundation. We’ll explore the Balance Sheet, the story it tells you about your business, and some areas to focus on to improve it.

Your Balance Sheet: What is it?

Let’s start with the basics. Your Balance Sheet, also known as a “Statement of Financial Position”, gives a snapshot of your business’s financial health at a specific point in time. It measures the net worth of your business, which is your assets less your liabilities. It also shows if your business is solvent; if your liabilities are greater than your assets, then the business is insolvent and needs urgent action to fix this.

But the Balance Sheet is not just a static document. You can compare different periods to determine how your business’s net worth is changing over time. It also gives you a basis to calculate key ratios such as debtor days, creditor days, and working capital. In short, the Balance Sheet shows where the cash in your business is tied up. There are some useful calculations that can be done to show how much cash can be created by influencing other numbers on the Balance Sheet.

Just as a lender will look at your Balance Sheet to see if your business is solvent, so should you. Trading while insolvent is not only extremely stressful, but it also potentially puts you personally at risk with creditors, ATO, and lenders. We’ll show you how to test if your business is solvent.

The Four Key Areas to Focus on Your Balance Sheet

 Let’s look at the four most important areas you need to focus on to build a stronger Balance Sheet.

1. Profitability

First and foremost, a healthy business is a profitable one. Without profits, cash will eventually run out and your business will become insolvent.

The best way to increase your profit is to choose one or two ways to grow and focus on those.

2. Cashflow

Cash is vital to any business, and without it, you can’t pay bills, employees, or taxes. This is why it’s often described as the oxygen of a business.

Your balance sheet can tell you if you are running into cash flow issues. Check your current ratio (current assets divided by current liabilities). If it’s less than 1 then the company is technically insolvent.

And your cash conversion cycle will tell you how long cash is tied up on your balance sheet. 

So, what can you do to improve your cash flow? Here are some practical strategies:

·       Review your trade debtors and chase any overdue invoices.

·       Negotiate better payment terms with suppliers to improve your creditor days.

·       Look for opportunities to sell off any unused or underutilized fixed assets.

·       Reduce any unnecessary expenses, such as subscriptions or software licenses, to free up cash.

·       Consider refinancing or consolidating any high-interest debt to reduce your interest payments.

And, to be prepared for times of economic downturn, make sure you have set aside a cash buffer to give you and your business some breathing room.

3. Solvency

Your business might be profitable but if you’re not managing your spending or cash flow wisely, it might not be solvent.

To be solvent, your current assets must be greater than your current liabilities, and your total assets should be greater than your total liabilities.

When a business is insolvent, it can’t pay its bills when they fall due, putting it at risk. 

4. Managing Director Loans and Personal Budgeting

As a business owner, it’s essential to avoid drawing too much out of your company for personal spending. Tax bills generally lag behind the revenue that you’re generating, so you could find yourself in a position where a surprise tax bill can’t be paid because you’ve taken too much money out of the business for your personal spending.

A risk with an overdrawn director’s loan account  (where you have borrowed money from your company) is that your personal assets may be at risk if a receiver or liquidator is called in. This is because the loan is likely to be called up.

Creating a personal budget, and sticking to it, is a really helpful way of making sure you don’t put unnecessary pressure on your business by taking out too much cash.

And while we’re on the topic of personal budgeting, it can really help if you set a regular monthly amount that you take from the business and stick to this. 

Get your Balance Sheet Right: The key to business success

Your Balance Sheet provides a snapshot of your business’s financial health at a specific point in time. It measures the net worth of your business, which is your assets less your liabilities. And it also shows if your business is solvent.

If you need help in understanding your balance sheet, get in touch!

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