Does your small business have a nice net profit so far this year? Great! However, if I asked you if your business was healthy and sustainable, would you know how to answer me? This is obviously a very complex question and involves analyzing several different aspects of your business model. But, if you are like many small business owners, you may not even know where to start to gather the numbers necessary to start to answer this question.
The Balance Sheet is an extremely crucial financial statement that many business owners overlook because they really don’t understand its importance or know how to read it. But, it contains the details you need to determine the health of your business. Some details you should be examining regularly:
- Assets vs. Liabilities – Your Balance Sheet will tell you if your business has a positive net worth: are your assets (what you own) greater than your liabilities (what you owe)? You may feel cash-rich because you just collected a large receivable balance, but if you have not yet paid the bills you incurred to perform that job, you are not necessarily in a good position.
- Retained Earnings – Contained in the equity section of your balance sheet are your Retained Earnings. Retained Earnings are the accumulation over the life of your business of annual profits, plus owner contributions, minus annual losses and owner distributions. What does this mean? If your current-year P&L shows a nice profit, but your Retained Earnings balance is either low or even negative, that means this one year is not indicative of how the rest of the years of your business have gone. Is this year a fluke (maybe you had one large revenue-generating project this year that is not expected to repeat), or are your current profits a good indicator of what to expect in future years?
- Current ratio (Current Assets – Current Liabilities) – Are your cash and receivable balances enough to pay your current bills, or are all your assets tied up in equipment that would not be easy to liquidate if times became tough?
- Debt to Equity (Total liabilities / Total equity) – How leveraged are you? You may have a nice profit this year, but if you are heavily indebted, can you weather the lean years?
Remember that your current-year net profit does not necessarily indicate the health and sustainability of your business. You need to take into consideration the bigger picture. If this is overwhelming, give us a call. We are always happy to meet with you to discuss your financials in detail.