Warning Signs On Your Business’s Balance Sheet That You Need To Address ASAP

The paperwork and endless record-keeping of a business can take up so much energy and be so tedious. It’s so easy to let financial records slip to the back of your mind, focusing instead on the daily operation of your business and trying to plan for its future. Most business owners don’t really take a hard look at their financial records until tax season comes around or they are trying to get approved for a bank loan.

While financial statements can be a hassle for a business owner to review, they provide a wealth of information to the owner who chooses to review them on a regular basis. Financial statements tell the owner of a business where the business is today and where the business is going in the future. The income statement of a business reports the results of the business’s operations for a specific time period (i.e. a month, a quarter, a year). On the other hand, the balance sheet of a business reports the financial position of the business at a single point in time. For example, a balance sheet might report the financial position of a business at the end of the year. Using the balance sheet of a business as an example, the balance sheet lists all of the assets of the business on the left side of the statement and all of the liabilities and stockholders’ equity on the right side of the statement. In other words, the balance sheet shows what a business owns and what the business owes.

When ignored, the changes to a company’s Balance Sheet can bring about serious problems in the company very quickly. However, most financial problems are not created overnight. Typically, they have developed over time with clear indicators along the way that could have been picked up and resolved if known. This article lists five major Balance Sheet indicators that any business owner needs to monitor closely and take action on immediately if they start to move in the wrong direction.

1. A Consistently Declining Cash Balance

Your business can be making lots of money and have many customers but if you do not have any cash in the bank to pay for the operation of your business then your business will die quickly. So the first sign of financial trouble on your Balance Sheet is the decline in your cash reserves over a period of time. It doesn’t matter how fast your sales are growing if your cash is not growing then you are losing money.

When cash reserves are decreasing, while sales are increasing, money can become “trapped” and not available for immediate use. For example, money may be tied up in accounts receivable or in excess levels of inventory in a warehouse. The business will need liquid capital to pay for things such as paying employees, renting a facility and paying for utilities.

It’s simple to ignore your cash flow problems until they become too big to handle, but by the time your accounts are overdrawn it’s too late. Identify the problem, quickly and take action before your lack of cash brings your business to a grinding halt. Review your last few months’ cash flow, check for any irregularities and cut back on non-essential spending until the problem has been solved. Go back to your pricing strategy and check that you’re not paying your suppliers too quickly while customers are taking too long to pay you.

2. Accounts Receivable Growing Faster Than Sales

As the amount of accounts receivable increases, so too does the amount of money that your customers owe you for the work that you have done. However, if the amount of your accounts receivable is increasing at a much faster rate than your sales revenue then you have a problem collecting from your customers.

Overdue accounts will never be collected. The longer an invoice sits as an unpaid account receivable, the lower the chances of collecting the amount owed. In extreme cases, you can write off the invoice as a loss.

By utilizing a beginners balance sheet guide you will see how the current assets on your balance sheet affect your liquidity. Be sure to implement a strong collection policy. Try to send out your invoices right away after a job or delivery. Set up reminders automatically for past due payments. Also, try offering a small discount for paying early.

3. Inventory Stagnation and Slow Turnover

For businesses that sell physical products, inventory is often the largest asset on the balance sheet. It represents potential future revenue. However, inventory that sits on shelves for too long quickly transforms from a valuable asset into a costly liability.

Stagnating inventory has the power to suck the life out of your company. It prevents you from investing in more promising products that are moving quickly. The worst case is when the inventory eventually becomes obsolete, gets damaged or simply becomes worthless. And don’t forget that you will have to pay to store the stuff until it deteriorates or gets written off. This carries a number of hidden costs such as the cost of warehouse space, stock holding costs, insurance and stock protection.

However, high levels of inventory have many hidden costs as well, such as storing the inventory in a warehouse and paying to insure it, as well as hiring security to protect it. Review your inventory on a regular basis and be willing to cut your losses on slow moving products. Even running a promotion or two on slow moving items can be better than allowing them to continue to tie up cash on your balance sheet.

4. A Rising Debt-to-Equity Ratio

On the balance sheet, there are two ways that a business can be funded: with debt and with equity. The sum of the liabilities on a balance sheet equals the sum of the stockholders’ or owners’ equity. The ratio of the liabilities to the stockholders’ or owners’ equity is called the debt-to-equity ratio.

The debt-to-equity ratio is a calculation that lets you know how much leverage your company is utilizing. It’s calculated by dividing your total liabilities by your total equity. If the number of liabilities is increasing at a rapid pace and is becoming much greater than the equity in your company, you’re running your business with too much debt.

A high debt load can mean that a business is paying a lot of money in interest payments each month. These payments will be using up cash and this will be the case even if the business is making plenty of sales. The debt-to-equity ratio is an important factor that lenders and investors look at when deciding whether to lend to or invest in a business. A business with a high debt-to-equity ratio will be seen as a riskier business than one with a low ratio. This means that the business may struggle to get more credit in the future. Try to grow your business using the profits that you make from your operations rather than by taking on more debt.

5. Negative Retained Earnings

Retained earnings is the amount of net income from past years that a company has reinvested in the business and not distributed to the owners in the form of dividends. This figure is reported on the Balance Sheet under the Equity section.

If your balance sheet shows that you have negative retained earnings then this means that over the life of your business you have incurred more losses than you have made in profit. Whilst it is common for brand new start-up businesses to have negative retained earnings as they invest the initial start-up capital in order to facilitate early growth, this is a major concern for established businesses who are failing to return a profit.

As losses are recorded, the total equity of a company will begin to erode. Eventually, a company may report a negative total equity, meaning that its liabilities are greater than its assets and the company is technically insolvent. The process of returning to a state of financial health will require a careful evaluation of the company’s business model, significant reduction in operating expenses and an ultimate shift to become a more profitable company.