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FINANCIAL LITERACY •  23 JUNE 2021 • 8 MIN READ

Interpreting your balance sheet

Interpreting your balance sheet

We’ve prepared articles covering what a balance sheet is, and what you’ll find in it (if you’d like a refresher, just click on those links).

Your next question may be – what does it mean? Here are warning signs that may indicate your business faces difficulties.

Negative working capital

Working capital is the value of current assets less current liabilities. If your debtors were to pay in full, you sell all of your stock, and receive any refunds owing to you (for example, Inland Revenue), you should be able to pay all of your current liabilities.

If you have negative working capital, your current liabilities exceed your current assets. You need to address this pretty smartly. How will you pay creditors? Are you technically trading while insolvent (which is illegal)?

Debtors are higher than last year

This can signal that people are slower paying you. Maybe the increase in debtors is due to greater revenue, which is fine. However, go through the suggestions below, just to make sure!

You can run Xero’s Aged Receivables Summary report. This will show you the number of days since you’ve sent out the invoice.

  • Run through your receivables listing and overdue invoices and get in touch with late-payers, if you haven’t done so already
  • Consider utilising a debt collection agency; yes, they take part of the money received, but it’s still better than nothing
  • Look at your payment terms – are they too generous?
  • Should you start invoicing in advance for notoriously late-paying customers, or invoice according to your progress? This is a perfectly acceptable business practice and you’re getting paid up-front

If you’ve exhausted all avenues and unlikely to be paid, write off the bad debt in your accounting system. Writing off bad debts means you’re not paying tax on income you don’t expect to receive.

Average debtor days

This provides a rough guide as to how long it takes the average debtor to pay you. As with many calculations, the result isn’t as important as the trend. You can also compare the calculation against your payment terms.

Average debtor days = (accounts receivable divided by annual credit sales*) times 365 days

 An easy way to figure out your credit sales in Xero is through Account Transactions (Accounting / Reports). In the Layout section, select Group By…Source, then Update. You’ll see transactions listed under “Receivable Invoice”.

* Note here that we only count credit sales and don’t include cash sales.

Creditors are higher than last year

An increase in creditors could mean you don’t have sufficient funds to pay your suppliers on time. This can often be linked to the business’ debtors failing to meet payment deadlines. If you don’t receive payment from your debtors, you may not have sufficient money to pay your creditors.

If the increase is due to higher sales (which often means higher expenditure), then it may be acceptable. If it’s not, you need to pinpoint the reason.

You can run Xero’s Aged Payables Summary report if you’re using its billing system. This will show you the number of days since you’ve received their invoice. Try the average creditors calculation below as well.

Average creditor days = (accounts payable divided by annual supplier purchases*) times 365 days

  • Compare the trend with average debtor days. If average debtor days increase, it’s not unusual to see the average creditor days increase as well. After all, you’re not getting paid on time, so where do you get the money to pay your suppliers?
  • Are you incurring penalties and interest on late payments?
  • Can you get a discount by paying early?

* Note here that we don’t include purchases made with cash, debit cards, or credit cards.

Negative equity

Your total assets (current and non-current) should be higher than your liabilities (current and non-current). If not, then you’re in a negative equity position and legally insolvent. Trading while insolvent is considered to be reckless trading, and directors can be held personally liable by creditors.

Exceptions

There are two exceptions:

  1. If the company’s balance sheet shows a shareholder current account or a loan to you, it still owes you money, but paying creditors is the priority.
  2. Your non-current assets may not reflect their true value. Your balance sheet may show the asset at its cost price (for example, a property), but its market value may exceed this.

If, after you:

  • ignore the shareholder current account or personal loans, and/or
  • take into account an asset’s market value,

the business has positive equity, then you can breathe a little easier. If you’re still in negative equity, then you have a real problem and should seek professional advice.

Who are Beany?

We’re an online accounting firm that is always right here for you, your accounting pain relief. The most advanced technology lets us work way more closely with you than a normal accountant would. 

We have a dedicated team of remote accountants to take care of your business no matter where you are, so you can focus on growing your business. We take out the ‘fluff’, break down the barriers and get things done. Looking out for you is what we are all about. Get started for free today.  

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