Business owners tend to focus on increasing profit and driving down costs. While this is important, you must not neglect your Balance Sheet. Profitable businesses can and do go broke; your Balance Sheet is a key indicator of how solvent your business is.
Here are four key areas of your Balance Sheet to focus on:
1. Profitability. There are seven ways to grow your business and increase profit:
Increase customer retention
Generate more leads
Convert more prospects
Increase transaction value
Increase transaction frequency
Reduce variable costs
Focus on one or two to increase the profitability of your business.
2. Cashflow. Improving your cashflow helps build a cash war chest to help your business weather any future downturns. Remember, cash is king, and the more cash you have in your business, the stronger it will be.
Focus on strategies to reduce your Cash Conversion Cycle; that is, the time your cash is tied up in your stock and accounts receivable. Negotiating better payment terms with your suppliers to preserve cash for longer, reducing inventory or work in progress, and minimizing debtor days will all help build a stronger Balance Sheet by increasing your cash on hand.
3. Solvency. Maintaining solvency is essential to the success of your business. There are two components of solvency:
The ability to pay your debts as they fall due; and
Having greater assets than liabilities To determine whether you can pay your debts as they fall due, calculate your current ratio by dividing your current assets by your current liabilities. A ratio of less than 1 means you don’t have enough assets to pay your debts as they fall due and the business is insolvent.
The second part of the test is calculated by taking away your total assets from your total liabilities. A negative result means your business is insolvent and requires a short-term cash injection.
If your business is currently insolvent, action must be taken immediately to remedy this.
4. Shareholder/Director of Current Accounts. If your Current Account is a current asset on your Balance Sheet, the shareholders and/or directors have taken more out of the business than what they’re entitled to. This not only has tax implications but is incredibly risky as, in the event the business fails, liquidators can call up this loan and your personal assets will be at risk. To avoid an overdrawn Shareholder/Director Account, revisit your personal budget to reduce the number of drawings you’re taking from the business and stick to a regular amount each week or month.
It’s important that you secure any advances made to the business so that, in a liquidation, you stand a higher chance of getting your money back.
Have you been neglecting your Balance Sheet? Take some time to review your profitability, cash flow, solvency, and Current Accounts. If you need help calculating your ratios or understanding what your Balance Sheet is telling you, get in touch!