As a business owner, you’re carefully watching your sales and hopefully keeping track of your expenses and bank account balance. But beyond the day-to-day monitoring of your key financial numbers, you should take a step back once a month to do a monthly financial review meeting.
Taking the time to zoom out and look at the big picture is a chance for you to evaluate your business.
Are things working as you expected?
Should you make changes to your strategy?
A key part of your monthly financial review meeting to help you answer these questions is taking a look at your balance sheet and conducting a balance sheet analysis.
Why do a monthly balance sheet analysis?
Your balance sheet gives you a quick view of your business’s assets (what you own) and liabilities (what you owe). It also tracks owner and shareholder investments (equity), but that’s less important for most small businesses to keep an extremely close eye on.
Your profit and loss (also known as a P&L or an income statement) tell the story of your sales and your expenses.
Your cash flow statement tells you how money is moving into and out of your business.
But, neither of these statements gives you a complete picture of where your business stands financially. That’s where your balance sheet comes into play.
To give you an idea of what your balance sheet should look like, here’s an example of a balance sheet pulled from LivePlan:
What does your balance sheet tell you?
Here are the questions your balance sheet can answer for you that your other financial statements can’t address:
How much money is in the bank?
This is probably one of the most frequent and most important questions that a business owner asks themselves. Knowing what you have in the bank is the key to most financial decisions.
The amount of cash that your business has on hand is listed in the assets section of your balance sheet and is classified as a “current asset.” Current assets are cash and other things that you can quickly turn into cash to pay your bills.
Are you owed money?
Keeping track of how much money you are owed is also an important part of your financial position. You’ll find this number in the accounts receivable row on your balance sheet.
If your customers don’t pay you in cash—you send them invoices and they pay later—this is where you’ll find what’s owed to you.
As your sales increase, this number is likely to increase, too. If some customers aren’t paying you as quickly as you would like, you’ll see this number grow. For most businesses, figuring out how they can convert accounts receivable into cash is an ongoing challenge.
How much inventory do you have on hand?
If you sell products, you deal with inventory. While your balance sheet doesn’t tell you exactly what products you have on hand and how many of each, it does tell you the value of that inventory.
Keep in mind that the value of the inventory listed on your balance sheet is what you paid for that inventory, not what it might be worth if you sold it to customers.
Inventory is a current asset because the assumption is that you can convert that inventory into cash relatively quickly.
What other assets do you have?
If you have other assets, both other current assets, and what are called “long-term assets,” you’ll also find those listed on the balance sheet. Long-term assets are things that you would typically hold for a longer period of time and are more difficult to convert into cash.
If you own the building that your business is in, for example, that would be a long-term asset.
In terms of a monthly financial review meeting, you’re probably less likely to need to keep close track of this number. It’s not likely to change significantly unless you are investing a lot of money into new buildings and large equipment.
All of your assets will be totaled up to show you the total value of all the assets you have — from cash and inventory to accounts receivable and long-term assets.
What bills are outstanding?
Just like you’ll want to keep a close eye on who owes you money, you’ll also want to track how much money you owe to your vendors. Like most businesses, you probably don’t pay bills the day they come in — you probably wait 15, 30, or maybe even more days before paying. Those accumulating bills will show up on the accounts payable line of your balance sheet.
How much cash you have in the bank and how much your customers owe you will likely be factors as you consider how quickly you want to pay those bills.
How much do you owe?
In addition to bills from your vendors, your business is probably accumulating other debts. Those are called “current liabilities” and will show up on your balance sheet in that section.
Examples of these other debts are things like sales tax that you’re collecting from your customers and need to pay to the government, income taxes, and other short-term loans that you may have.
You may also have long-term liabilities which would be something like a 30-year loan for your building.
Everything that you owe will total up in the liabilities section of your balance sheet, showing you exactly how much your business owes.
How to analyze your balance sheet using ratios
A great way to do a balance sheet analysis is to monitor key ratios that will give you a quick snapshot of your business’s financial health. While there are many ratios you can review for your business, there are two in particular that relate to the balance sheet and will give you important insights into your business.
The current ratio measures your business’s ability to pay back its debts—its short-term liabilities in balance sheet jargon. You calculate the ratio by dividing current assets by current liabilities:
Current Ratio = Current Assets / Current Liabilities
You want this ratio to be above 1. If the ratio falls below 1, it’s a warning sign that your business may not be able to pay its debts when they become due. This isn’t always bad news — it just signals that you should look into how your business is running. In some industries, it’s perfectly normal for businesses to carry a lot of debt, which will make the current ratio low.
The quick ratio is a variant of the current ratio. Unlike the current ratio that looks at all of your business’s current assets and assumes you can use them to pay bills, the quick ratio only looks at the cash your business has on hand plus accounts receivable (money that your customers owe you).
Quick Ratio = (Cash + Accounts Receivable) / Current Liabilities
Like the current ratio, you want this number to be higher than 1, and the higher the number, the better.
Balance sheet reviews should be quick and easy
The reality is that it probably took you longer to read this article than it will take you to review your balance sheet on a monthly basis. It may seem complex at first, but with a little practice and an understanding of what the numbers mean and what they tell you about your business, you’ll be able to read a balance sheet in a couple of minutes.