Let’s consider our thought of the day:
“The secret of change is to focus all of your energy, not fighting the old, but building the new”- Socrates.
That’s pretty deep.
This article is about building a better Balance Sheet, which can initially seem quite technical and a bit daunting, but stay tuned and you’ll get clearer on the power and opportunity that lies within in.
Before we get stuck in, I just want to throw in our usual disclaimer, that the information in this article is general in nature and no substitute for tailored advice, specific to your particular circumstances – so if you want to skip ahead and talk to me directly, click here to book a call.
So, here’s what I’m going to cover in this article
We’ll talk about the Balance Sheet, the story it tells us about our business, and discuss some practical and proven strategies for a stronger Balance Sheet.
We’ll also cover your four most important areas of focus, ways to maximise business value and then some best practice tips, as well as your next steps and how we can help.
So often we see business owners and consultants focusing all their energy on the Profit and Loss Statement – looking at ways to drive up revenue and drive down costs.
While this is important, unless there’s a focus on the Balance Sheet, profitable businesses can and do go broke.
For example, if you drive up sales but don’t have a great system for invoicing your clients or collecting the money owed, the business can run out of cash.
Likewise, a growing business may over-invest in stock and then, in a downturn like some are experiencing now, find it difficult to move this stock and convert it into cash.
Cash is often described as the oxygen for the business. There are many ways to increase cashflow, which I’ll cover shortly.
The Balance Sheet is where your cash is measured – there are some useful calculations that can be done to show how much cash can be created by influencing other numbers on the Balance Sheet such as debtors, stock and work in progress.
Just as your banker will look at your Balance Sheet to see if your business is solvent, so should you.
Trading while insolvent is not only extremely stressful as you’ll find it very difficult to pay the bills, it also potentially puts you personally at risk with creditors, the tax department and financiers.
We’ll show you how to test, at a glance, if your business is solvent.
In a downturn, it’s important to make sure you’re not drawing too much out of the business for personal spending.
Tax bills generally lag behind the revenue that you’re generating, so you could find yourself in a position where a surprise tax bill can’t be paid because you’ve taken too much money out of the business for your personal spending.
A personal budget update is strongly recommended at this time.
Having a war chest of cash is essential in times of economic downturn. If profits are down, or if you’re making a loss, a strong Balance Sheet can see you through until profitability is restored.
Now we know why we need to focus on the Balance Sheet, let’s talk about what it actually tells us.
Your Balance Sheet, also known as a Statement of Financial Position, provides a snapshot of your business’s financial position at a specific point in time.
It measures the net worth of your business, which is your assets less your liabilities. It also shows if your business is solvent; if your liabilities are greater than your assets then the business is insolvent and urgent action is needed to fix this.
You can also compare different periods to determine whether the business’s net worth is increasing or decreasing between years and can track the strength of the business.
“Most businesses only start worrying about their financial stability once things have already started going downhill. But by that point, it’s often too late.
A successful business requires constant attention and care. As a business owner, you can’t afford to wait until tax time to review your financial situation.
You need to be monitoring your progress on a quarterly or monthly basis.
If your not having quarterly or monthly meetings with your accountant, you could be putting your business at risk.
Don’t wait until it’s too late to get your finances in order”.
The stronger your Balance Sheet, the easier it will be for your business to survive a downturn.
It also provides a basis to calculate key ratios, such as debtor days, inventory days and working capital.
Let’s look at an example….
And now, let’s look at our liabilities.
Let’s look at some specific strategies to adopt.
In the current climate, it’s likely that many company Balance Sheets would’ve taken a hit from a downturn in business.
What’s important is to focus on what you can control and adopt practical and proven strategies to bolster your Balance Sheet.
There are four areas of focus for building Balance Sheet strength:
- Focus on increasing profitability – which is incredibly important in the current climate.
- Focus on improving cashflow – there are a number of ways to do this which I’ll explain shortly.
- Focus on solvency – that is, whether your business can pay its debts as they fall due and whether assets are greater than liabilities. Having real time, up to date information is very important to determine solvency. And lastly,
- Focus on your Shareholder Advance Accounts – as these measure whether you’re taking more funds from the business than are owed to you as shareholders. Having a dividend and drawings policy is essential to ensure you don’t end up with an overdrawn advance account, as liquidators can chase you personally for the balance owed. Revising your personal budget is an important action if you haven’t done so already.
The first of our four areas of focus is profitability. The best way to increase your profit is to choose one or two of the following seven ways to grow your business:
1. To increase customer retention, build a plan to delight your clients. Under-promise and over-deliver to them so they refer more customers to you and don’t defect to your competition.
2. To generate more leads, focus on your marketing, especially via referrals, testimonials and social media as these are all relatively cost-effective strategies.
3. To convert more prospects into customers, look at strategies that will increase your proposal or quote acceptance rate. Perhaps some sales training could be in order.
4. To increase your transaction value, implement strategies to encourage customers to spend more with you every time they buy. Perhaps offer options to up-sell, pick up on that very well-known concept of offering fries with that.
5. To increase your transaction frequency, look for ways to encourage your customers to buy from you more often. For example, offering loyalty benefits, a reminder service or simply staying in contact with your customers more so you’re always front of mind.
6. To reduce your variable costs, identify strategies to eliminate wastage and re-work. Also consider negotiating better pricing with your suppliers.
7. And finally, to reduce overheads or fixed costs, review these at least annually to ensure you’re getting the best deal and that they’re still required. For example, if more of your team are working from home, could you downsize your office space to reduce rent? Or could you get a better deal on your utilities by changing providers? It’s important to be careful that you’re cutting the fat and not the muscle. Some overheads could be seen as investments. For example, investing more in your accountant to help grow your business.
Seriously though, many business owners see accounting and financial services as a necessary evil – something to be grudgingly paid for, but not an essential part of running a successful business.
However, this approach is short-sighted and ultimately counterproductive.
A good chartered accountant can be a invaluable asset, providing insights and advice that can help to grow your business.
In fact, investing in quality financial advice is one of the smartest things you can do for your business.
By taking a proactive approach to your finances, you can identify opportunities and avoid pitfalls that could otherwise set your business back.
I often say to people “If you think it’s expensive to hire a professional, wait until you hire an amateur“
2 Improve Cashflow
Kindly watch the video above.
Ultimately, cash is king and you want your cash conversion cycle to be as short as possible. The more cash you have in your business, the stronger it will be as it can weather downturns more easily. Technically, if you increase cash by collecting debtors, your net assets don’t improve (as debtors go down and cash goes up). However, the higher your debtors are, the more risk there is of non-payment. Also, the quicker you can convert your debtors and inventory into cash, the stronger your business will be.
If you can negotiate better terms for payment of suppliers, you can preserve your cashflow for longer. Care is needed here though as, in the current economic climate, slow payment of suppliers puts a real drag on the economy. What’s important here is to come to an agreement with suppliers. For example, they might agree that you only pay when you’ve sold the item to your customers.
You must also look at how long it takes for your stock or work in progress to be invoiced. The quicker, the better. Consider whether you need to hold so much stock or if you can issue progress invoices or reduce the number of jobs you have on the go at once.
Make sure you’re also keeping a close eye on how long it’s taking for your debtors to pay you. There are so many things you can do to get paid faster, like updating your terms of trade, automated or repeating invoicing, or simply chasing up your slow payers with a systemised process or credit manager.
Play the video below for an example.
So, to recap, our first strategy was to build profitability and the second to improve cash flow.
3 Maintain Solvency
Now we’re onto our 3rd area of focus to bolster your Balance Sheet, which is to maintain solvency.
As mentioned previously, there are two components of solvency – often referred to as the first and second limb:
Firstly, the ability to pay debts as they fall due, which is measured by ensuring that current assets are greater than current liabilities.
The second part of the test is ensuring that total assets are greater than total liabilities; not just current ones.
Let’s go back to the example again.
And on to the next example, let’s look at the second part of the solvency test: Total Assets Greater than Total Liabilities.
Of course, the company still needs the previous strategies to increase profitability and cashflow, but at least the two limbs of the solvency test can now be satisfied.
4 Managing Shareholder Loans
Which brings us to the 4th area of focus to bolster the Balance Sheet: managing shareholder loans.
I’ve already covered the risks associated with overdrawn shareholder advance accounts; the main risk is that, if your company gets into financial difficulty and a receiver or liquidator is called in, your personal assets may be at risk as the loan is likely to be called up.
A great way to avoid an overdrawn Shareholder Advance Account is to update your personal budget so that you can reduce the amount of drawings you take from your company. Personal budgeting is a rewarding and empowering thing to do; especially in the current economic climate.
While we’re on the topic of personal budgeting, set a regular weekly or monthly amount that you take from the business and stick to this.
And lastly, to protect you in the event the business does get into financial strife, having security for advances you’ve made to your company ensures that, in a liquidation, you stand a higher chance of getting your money back.
So to recap, I’ve covered a huge amount of detail here and some of it is quite technical.
The main message from today is that your Balance Sheet is fundamental in assessing your business strength. There are so many things you can do to bolster your Balance Sheet, including strategies to:
- Build profitability.
- Improve cashflow.
- Maintain solvency.
- Manage shareholder advance accounts.
My aim is to help you take what you’ve learnt today and implement some positive change in your business.
So what are your next steps from here?
- Doing nothing is not an option. Doing what you have always done is unlikely to give you the same results as you’ve had in the past.
- Remember to put the oxygen mask on yourself first – planning for sustainable improvement starts with you and the leaders in your business.
- Make a clear plan for the steps you’ll take to bolster your Balance Sheet.
- Focus on what you can do as opposed to worrying about what is out of your control.
- We are here for you and want to help.
First of all, we can prepare a Cashflow Forecast to help you plan for cash inflows and outflows. To help you implement strategies to improve your cashflow, we offer a Cashflow Management Coaching service. Or, if you’d like more help to understand your numbers, we also offer Financial Awareness Coaching.
If you’re not quite ready to commit to a paid service, click here to download a complimentary Balance Sheet Health Check for you to complete to review your Balance Sheet and identify areas for improvement.
We could also catch up for a complimentary meeting to see how we can help you achieve your goals.
“Business is many things, the least of which is the Balance Sheet. It is a fluid, ever changing, living thing, sometimes building to great peaks, sometimes falling to crumbled lumps.” – Harold Geneen
Make a simple plan today – commit to at least three actions you will take as a result of today’s article. Write them down, give each of them an owner and a completion date. Remember, if you need our support, we are here for you. Click on the button below to book a discovery call – it’s free so you don’t need to think about it too much!
The best way to get to know your business is by getting to know your numbers, if you want to understand your numbers it’s vital to know accounting basics – click here to read the next article next!
Are you struggling to make your business work?
Insight CA Limited is a team of experienced Auckland-based chartered accountants and business advisors who can help. We’ll give you the power to see what’s really happening in your business, so you can take control and start making progress. Click here to learn more about how we can help you achieve your goals.