There’s always knowledge to be learned from a book and then there is the important stuff to be gleaned from running a business.
- A Balance Sheet is a snapshot in time, like a photograph. It is not a video. It cannot show motion. It can only show a static picture. That’s why conclusions based on balance sheets can be dangerous. e.g I have $1m in the bank therefore my business is safe. Sadly with a burn-rate of $500k per month, the last thing you are is safe!
- The difference between 2 balance sheets, taken at different times, is captured by a Profit and loss Account and a Cash Flow. A P&L and Cash Flow do show motion and speed. They measure the velocity of cash generation or profit generation.
- There are many ratios you can derive from a balance sheet, current ratios, quick ratios, debt to equity ratios but they are all useless without a trend of their movement.
- The most powerful balance sheet ratios involve taking an asset or liability and comparing it with an item from the Profit and Loss or Cash Flow and plotting it over time e.g.
- Stockturn – Revenue divided by inventory
- AR Days – AR balance divided by Revenue x 365 days
- Monthly Overheads divided by end of month cash balance
- Profit for the year divided by shareholders funds
- Market Value of the balance sheet divided by earnings for the year
- Balance sheets are the pillars that businesses are built on. They are either fit for purpose or they are not. Start Ups rarely have balance sheets fit for purpose and thus the mortality rate is to be expected.
- Balance sheets can be manipulated as easily as profit. Be careful to validate your asset balances, especially cash balances because they are derived from bank reconciliations. When something is derived it can be manipulated.
