What your balance sheet can tell you about your business

Reading financial statements is not the most exciting exercise on the planet, but for a business owner they can surface important information.

Understanding the numbers in your balance sheet can help you spot risks and make growth decisions as well as prove your financial stability to potential lenders or investors.

In this article we breakdown the questions your balance sheet can answer about your business.

The actual cash on hand figure separated from the expected future revenue that you haven’t actually received yet.

If your accounts receivable is high, you have money tied up in unpaid invoices. It may be worth checking that your collections process is working as expected.

Money sitting idle in the form of unsold stock (or raw materials) is money you don’t currently have available to pay upcoming bills.

This is useful for understanding the value of all the underlying assets that power your day-to-day operations and keep your business running.

Keeping an eye on your Accounts Payable helps you strike the right balance between holding onto your own cash as long as possible and keeping your supplier relationships on good terms.

Tracking what liabilities are due in the next 12 months ensures you’re not caught off guard by an upcoming tax bill, credit card payment or short-term loan.

Understanding your long-term liabilities is useful for knowing exactly how much of your future revenue is already accounted for.

A business’s net worth is essentially the same as equity i.e. total assets minus total liabilities.

By looking at retained earnings, you can see how much profit you’ve kept in the business to fund future growth.

As well as looking at each section of a balance sheet in isolation, it’s also useful to look at how they work together.

They can answer broader questions such as:

By comparing current assets (like cash and accounts receivable) to your current liabilities (like credit card balances, supplier bills, short-term loans), you can assess the business’s ability to cover its short-term obligations.

If your current liabilities are growing faster than your current assets, you could be getting close to a cashflow crunch.

Keeping an eye on this is essential for ensuring you always have enough cash (or assets that can be quickly converted to cash) to keep the business running.

Reviewing total liabilities against equity indicates how the business is financed. Whichever number is higher tells you where more of your funding is coming from.

Using borrowed funds for growth can be fine if some of the revenue gain is being used to repay that debt, but if it’s just covering day-to-day running costs, then it could be a sign that you’re relying too much on borrowed money.

If the business is heavily funded by debt (i.e. total liabilities is significantly higher than equity), it can become high risk when interest rates rise or the economy slows down.

Since a balance sheet is just a snapshot at a point in time, comparing balance sheets month-on-month or year-on-year is useful for spotting trends that a single statement won’t show.

Trends provide a good gauge of whether your business is getting healthier, maintaining the status quo (or close to it) or facing challenges that need to be addressed.

While a balance sheet is a great indicator of financial stability, it won’t tell you how profitable the business is.

A business can have a strong balance sheet and be losing money. Alternatively, a business could be highly profitable and have a weak balance sheet if too much of the business is being financed by debt.

This is why balance sheets and profit and loss statements are often read together since they answer different questions.

We recommend making a habit of reviewing these numbers regularly, so you can move from guessing how your business is doing to knowing where it stands. If you’d rather have an expert keep you accountable, then consider whether regular check-ins with your accountant would be beneficial. Quarterly or monthly meetings can turn these numbers from a chore into someone highlighting the ‘you should probably be aware of this’ and guiding your next steps.