Question # 5 - What is my business worth? It's not on the Profit & Loss!
The Balance Sheet is the true scorekeeper of your business.
One of the most dangerous health conditions is also one of the sneakiest.
According to the Mayo Clinic, high blood pressure is often called the "silent killer" because most people who have it don't have any symptoms. And that silence can be deadly. High blood pressure can lead to a host of serious problems, including heart attack, heart failure and stroke.*
Your business has a silent killer too.
And it lurks in a place that most business owners never look.
When you ignore your Balance Sheet you put your company at risk of death.
As a fractional CFO for small businesses and I have YET to meet a client that reviews his/her balance sheet on the regular. I have met a small handful that review their P&L regularly (a few times a year) but NONE that reviews their Balance Sheet. Nada.
They check their bank balance a lot. But your bank balance is not the only item on your Balance Sheet.
A good CPA once told me to review a client's Balance Sheet FIRST, before their Profit &Loss. Why? Because the Balance Sheet tells the story of the health of the business. The P&L tells you how the business performed during a time period. The P&L shows if you are winning the inning or quarter. The Balance Sheet reports if they are winning the game. It's the true scoreboard.
Let's talk about the different parts of the Balance sheet. If you have read this far, I strongly urge you to print out your latest Balance Sheet. Follow along with that document in your hands.
The Balance Sheet begins by showing how much the business owns in Assets. Those are "things"that are cash or can be converted into CASH. We like those. How is your Asset number?
The Balance Sheet next reports how much the business OWES. This number alone can deter a bank from giving your business a loan. Just how the balance of your credit card tells how well you manage both yourself and your money (don't get me started on sky-high credit card debt most people carry), the Liabilities section, or what you owe, tells me how well this business owner manages his/her business. How about the Liabilities number? Good? Bad? Don't know?
Here's a CFO tip: take the number called Current Assets and divide it by the number called Current Liabilities. This is called the current ratio and it basically shows if you have enough cash in the bank and receivables to pay your short term bills. If the number you calculated is greater than 1, then the business has enough money to pay it's bills. If the number is less than 1 that means you don't have enough cash to pay your short term obligations. You cannot see that looking at the P&L.
Almost every business I owner I work with wants to, eventually, sell the business for "big money". They see it as their retirement plan. The Liabilities section of the Balance Sheet lists what the owner needs to repay before he can line his 401K with the proceeds. When I point out that you must subtract the Liabilities from the proceeds of the sale of the business, they are usually sobered that what is left may not buy that retirement Porsche they have their eyes on.
Generally we see bank loans listed in this section. Which brings me to newest liability appearing everywhere: the EIDL Loan.
EIDL stands for Economic Injury Disaster Loan. Many business owners applied for these low interest rate loans during COVID. Most needed them to survive. Some applied just because it was "almost free money'.
COVID-19 EIDL loans were offered at very affordable terms, with a 3.75% interest rate for small businesses and 2.75% interest rate for nonprofit organizations, a 30-year maturity. Interest continues to accrue during the deferment period and borrowers may make full or partial payments if they choose.
30 years ... did you get that? Your business has a mortgage. This debt needs to be paid back. What's the plan to do that?
Finally, the Balance Sheet tells the story of what it took to build your business: Owner's Equity.
What is Owner’s Equity?
Owner’s equity is essentially the owner’s rights to the assets of the business. It’s what’s left over for the owner after you’ve subtracted all the liabilities from the assets.
The term “owner’s equity” is typically used for a sole proprietorship. It may also be known as shareholder’s equity or stockholder’s equity if the business is structured as an LLC or a corporation.
What’s included in Owner’s Equity?
Owner’s equity includes:
Money invested by the owner of the business
Plus profits of the business since its inception (where is all that money?)
Minus money taken out of the business by the owner
Minus money owed to others - like that investor who is waiting to be repaid.
If the business is structured as a corporation, equity may also include accounts like:
Additional paid-in capital
Is Owner’s Equity an asset?
Business owners may think of owner’s equity as an asset, but it’s not shown as an asset on the balance sheet of the company. Why? Because technically owner’s equity is an asset of the business owner—not the business itself.
Business assets are items of value owned by the company. Owner’s equity is more like a liability to the business. It represents the owner’s claims to what would be leftover if the business sold all of its assets and paid off its debts.
Many business owners I work with have a negative balance in Owner's equity. That means the business owner could be upside down, or owe more than he/she has invested. The business did not perform as expected (Retained Earnings) or the owner took out more money than the business actually made. Yep. That happens. A lot.
So, how healthy is the Balance Sheet for your business? If you need help getting it in shape, schedule a call with me at www.speakwithdiana.com