The answer:  Increase your knowledge; this will accelerate your ability to take leadership in the management of your company’s financial performance. This is the single most important thing you can do to protect your security.

Here are some of the biggest underlying factors faced by business owners that hamper their future profitability, improved cash flow, increased value (most business owners largest personal asset) and ability to grow their business:

• Business owners rely too much on their accountant and/or controller for financial control and understanding what is going on “financially” in their business
• Most business owners have a poor understanding of the financial systems in their company: accounting, profitability, cash flow, what drives profitability and cash flow
• Nearly 90% of business owners don’t have any financial matrix to manage their company.  They rely heavily on someone else for financial input
• Most business owners manage finances as a reactive process and not proactive.  That is why the top 25% of any business segment makes 200% to 300% more money than the bottom 75% of the businesses in their industry.

Is it time to start being PROACTIVE with your personal financial security and protecting the value you have created in your business?  If you answered yes to this question, there is a unique opportunity for you to reach your personal and financial objectives. It has taken me 20 years to develop the techniques and processes that are taught in this workshop.  These processes have led to $900,000 improvements in profit in multiple companies in just a few short years.  It can work for you.

There are a few seats left in my 20/10 financial management/workshop.  The cost is low and affordable and it comes with a 100% money back guarantee.  That is right, I will refund every penny of your money to attend this seminar if you don’t increase profits in your company 20% more in 2011.  Sessions begin September 16 and September 24.  Don’t be left out; don’t lose the opportunity to grow your knowledge and financial understanding.  Here is a summary outline of the course:

Cracking the financial code

• Financial statements: “friend” or “foe”
• Secrets are hidden in the numbers
• Understanding the financial dynamics of a growing business

Identifying the keys to explosive profitability

• Understanding your 4 profit drivers
• This simple method that will double profit in 12 months
• How to pay yourself more
• Why knowing your “magic number” is critical to success

Improving cash flow

• Discovering your 7 cash flow drivers
• How balance sheet management can negatively impacts cash flow
• 27 more tips to improve cash flow

Financing the growing business

• How to get financing in today’s economy
• Strategies for decreasing borrowing costs
• What bankers mean by credit worthiness

Preparing your exit strategy

• Why you need an exit strategy
• Determining what your company is worth
• 7 ways to exit your business (some are not planned)

Maintaining Control

• Putting it all together
• Developing a dashboard that will guide daily performance

My promise to you: attend this workshop and you will see dramatic improvement in your company.

Email me today for additional information, availability, cost and payment options. Dan@DynastyBuilder.com or better yet call me at 765-644-8887.

To Your Business Success:

Dan Lacy

How would you like to dramatically change the dynamics of your business and make more money?  I am taking about serious money, at least a 20% improvement in your profit next year.   I am very serious.  All it takes is an investment of your time over the next 4 months and your knowledge about making money will dramatically increase.  This is 100% guaranteed to work.  This is a proven method I have used with my clients over the last 15 years – they have made millions of dollars in profit using these techniques.

Over the last two years I have been conducting a workshop for business owners teaching them everything I know about business finance, growth management, financing and how to make much more money.  This course consolidates 25 years of business experience into eight – 2 hour courses.  This series starts this month and there are two tracks, one starts on September 16 and the other on September 24.  To learn more, save a seat or make a comment, email me: Dan@dynastybuilder.com.

What you get: 1) 16 hours of instruction over 4 months in 2 hour segments, 2) 250 page workbook, 3) my book “Cracking the Financial Code”, 4) an evaluation of your business with (at least) 6 ways to make more money, and 5) a fun give and take learning experience.  All with a 100% money back guarantee.

Outline of the course is as follows:

Session 1: Cracking the Financial Code

• Financial statements: “friend” or “foe”
• What the numbers mean (making the complex easy)
• 5 steps to creating more money through understanding
• What you and don’t want from your accountant

Session 2: Identifying the Keys to Explosive Profitability

• Understanding the 4 profit drivers
• A simple method that will double profit in 12 months
• How to pay yourself more
• Why knowing your “magic number” is success critical

Session 3: Applying Financial Understanding to Improving Profit

• Review
• Q & A
• Bench Marking Your Company in your industry
• Case Study

Session 4: 9 Steps to Improving Cash Flow

• Discovering your 7 cash flow drivers
• How a mis-managed balance sheet can negatively impacts cash flow
• Always have adequate cash flow to run your business – guaranteed

Session 5: Digging Deeper: How to improve cash flow in your business

• Review
• Q & A
• Case Studies
• Understanding the difference in your businesses cash cycle and cash flow
• Strategies you can employ to speed up cash coming into your business

Session 6: How to Finance Any Business

• How to put together a financing package that will get the financing you need
• Identifying the 57 other non-bank financing sources
• What a lender looks for in a loan package
• How to choose a bank that will stick with you (all banks are not created equal)

Session 7: Looking Ahead – Preparing Your Exit Strategy

• Why you need an exit strategy
• Valuing your company and get a real number of its value today
• 7 ways to exit your business
• What to do in the 24 months prior to putting your company for sale

Session 18: How To Sleep Better At Night With Confidence

• Putting it all together
• Developing a dash board that will guide daily performance
• Review of the key components that will drive the business forward
• Determine what you must do daily, weekly, monthly to consistently improve the performance of your business

The cost of the program is $995 which comes with a 100% money back guarantee.

I personally guarantee that when you follow these techniques, which are easy to implement in your business, you will see dramatic improvements in your business.  If you don’t, I will happily refund your money.

TO LEARN MORE – email Dan@DynastyBuilder.com

For over 25 years, I’ve been working with business owners who want to consistently improve the performance of their business.  In that time frame, there have been some pretty amazing success stories: companies seeing 30% compounded revenue growth, profit dramatically improving, and the owners taking home real money.  In looking back at the results, 19 of my clients have passed through the magic $1,000,000 personal net worth mark, due to the success of the cash flow of their business.

Whether you have a small, mid-sized, or large company, here are five tips that will help you be better and make more money:

1. Dominate your market.  Find an underlying advantage that will propel you ahead of your competition.  How do you do this? Look at your firms two largest costs; focus on how to stream line and improve the process.  Be much better than anyone in your market.  Have a brain storming session with your key managers – push them to think outside of traditional procedures. Find ways to improve speed, cost, and productivity.
2. USP. Your Unique Selling Position is critical in today’s competitive environment.  Everyone in your organization needs to know what makes your company: a) more unique, b) more valuable and c) a better choice (to your customers). Your employees need to be able to communicate this effectively, as with your advertising and marketing. The central theme in your marketing should always be consistence and repetition.
3. Focus.  Set clear goals for the next 90 days that you communicate to your management team (and maybe all of your employees). This could include: sales, gross profit margins, profit, accounts receivable, inventory turns (reduction), or unlocking a major bottle neck in your company; these are examples of what your management team can rally around and work towards.  Weekly meetings help keep the focus on the issues and measure progress towards your defined objective.
4. Control Your Cash. If Elvis is the king of Rock ‘n Roll, then cash is the king in business. A growing business consumes cash, so it is critical to construct a process in which you always know that you will have adequate cash to operate your business. Ideas can include: weekly billing, one person in charge of collections, a follow-up system on slow accounts receivables, a person(s) in charge of each line item in your expense section of your profit and loss statement, and most importantly (because this will bring all the elements of cash flow management together) a cash flow forecast.  A cash flow forecast is a spreadsheet that projects all the future sources and uses of cash in the business.  An updated monthly (or weekly) cash flow forecast is an early warning system on your cash position. This is the only effective way to “look into the future” of your business for anything you can do. Successful businesses always produce an updated monthly cash flow forecast – always.  This will take the stress out of managing cash.
5. Know Your Matrix.  Profitable growing businesses know their strengths and weaknesses; they know where they have been and where they are going.  It is critical that you know the 5 to 10 key indicators that drive the success of your business.  Most businesses fail to do this and operate by the seat of their pants every day.  Here are some ideas: break-even point (break-even point by division), profit, collected money, cash position, recalls, call backs, number of new customers, on-time delivery, and so on.  Every business and industry will be different, pick those that best reflect the overall picture of your business and review them weekly.

If you do this, you will see steady improvement in your business, I personally guarantee it.  This system has worked for me for years.

Much of what I do with clients revolves around the processes I have just described. While I have always preached on how critical it is to set revenue goals and march toward them, being a sounding board, a confidant, and accountability partner is just as important. If you need help in any of these areas, please give me a call or send me an email.

To Your Business Success:

Dan Lacy
Growth & Profit Coach, Financial Strategist, Cash Flow Doctor, CEO Mentor

P.S. I have received rave reviews for my book – Cracking the Financial Code. This is the most practical book on understanding your financial statements, and how to use them in your business. Get your copy now for only $15.

Go to:

www.dynastybuilder.com to order now.

Here’s what others have said about this book:

“Cracking the Financial Code removed both the mystery of financial statements and my excuses for not diligently using them.  This is a must-read for any business owner wanting to make informed business decisions.”
Jonathan Arnold, President, Tuitive, Indianapolis, Indiana

“In Cracking the Financial Code, Dan has taken difficult financial concepts and made them easy to understand.  This is a “must read” for business owners who want to grow their business.”
Kirk Klabunde, Senior Vice President, First Merchants Bank, Anderson, Indiana

“Cracking the Financial Code is a terrific reference source for growing companies to make sure their financial focus is sound.”
Terry J. Pahls P.E., President and COO, I Power Energy Systems Anderson, Indiana

This is a money/cash flow issue, making sure there is enough money coming in to meet the monthly requirements of paying your salary, overhead, vendors and labor (the money going out). For most young and growing businesses this is a plaguing problem.

There are a number of reasons why this can be a problem for any business:

1. the company is not profitable
2. the company’s accounts receivable and/or inventory is expanding faster than revenue is rising
3. the revenue stream is seasonal – high revenue where it is difficult to keep up in half the year and slow (people looking for work to do) in the other half of the year; for example a lawn mowing business.
4. the company’s revenue is growing faster than working capital can support.

Here are some ideas for solving these lingering problems.

1. No profitability – the primary causes for this is not having a profit goal for the year. More than 85% of business owners won’t set this goal for the year.  They like to be surprised when their controller or accountant tells them how much they made or lost at year end.  This is like going to a Colts game and not knowing the score until the game is over – not a very exciting way to watch a game; not a very good way to run a business.

First determine how much money your business should be making per year, this is determine by profit as a percentage of revenue (check your industry standards to determine this) or use 30% return on equity (equity on balance sheet X .3).  The most important thing is to determine how much money you want to make and manage to it.

If you do create a budget for the year, make sure that you look at it monthly and manage to it.  And don’t change your profit budget.

2. Growing accounts receivable and inventory faster than revenue.  One of the biggest challenges for growing businesses is to manage the growth in current assets; every dollar growth in accounts receivable or inventory sucks cash out of the business.  Controlling the growth of these two assets is really important to managing cash flow.

Review your accounts receivable aging report monthly.  Follow up quickly on slow moving accounts.  Take action and don’t pass this responsibility to someone else without looking over their shoulder regularly.  Also, do a turn analysis on accounts receivable and inventory quarterly and compare that with the previous year and see if the days on hand of inventory and accounts receivable is getting better or worse.

3. Seasonable revenue.  It is really difficult to grow a business when revenue varies widely from one season to the next.  Solving cash flow problems in this type of business is only accomplished when enough cash is made to carry through the down months.  This can only be accomplished when revenue and profit targets are established and managed to through the good times and controlling expenses in the slow times.  Planning is critical to this type of business.

4. Dramatic growth.  Fast growing businesses will have more cash stress than businesses that are growing slowly. As revenue grows, accounts receivable and inventory expand to keep up with the growth in revenue.  Labor is also accelerated to perform work that gets paid for down the road.  If extended payment terms are granted to new clients to induce them to buy more, the problem becomes compounded.  In a business that is growing, cash flow planning is critical because CASH sustains the growth, any hick-up in financing, collections or a glitch in inventory management greatly enhances the cash flow risk.  A Cash Flow Forecast is a early warning system to alert you when you will have a cash flow shortage – but you will have plenty of time to prepare or change direction.

Summary – I would strongly recommend a cash flow forecast to reduce the stress you have relative to your business.  It will help you plan better, see into the future and give you a better nights sleep.

To Your Business Success:

Dan Lacy
Growth & Profit Coach, Financial Strategist, Cash Flow Doctor, CEO Mentor

Unfortunately, many business people have not come quite as far since the Depression, in their ability to discern what makes a company or organization work and what needs to be done to ensure its survival. There are basically nine “danger signals” that indicate the strength and viability of a business is deteriorating:

1. Declining gross income, combined with operating losses. In most instances, declining sales will not be targeted as a problem until operating losses deplete cash reserves. Normally operating costs will remain high and not be adjusted as sales decline. This creates the operating losses that eat up cash reserves.

2. The absence of an operating plan to guide the company. Most managers do not use a carefully crafted planning procedure to create an on-going validation system. If a planning document exists, it is often shelved and forgotten as day-to-day concerns take precedence over future goals. When this happens, management has little or nothing to measure itself against and is oblivious to hidden dangers.

3. Breakdown in communications between upper management and the labor force. Failure to communicate vertically creates a situation where upper management cannot identify conflicts that exist in the on-going operation of the organization.

4. Inadequate cash flow. The ability to generate cash flow is the key ingredient in a successful business operation. Without adequate cash flow, an organization is doomed to failure. While it is normal for most organizations to have seasonal fluctuations, balancing these adjustments is critical for the survival of any organization.

5. Inability to convert accounts receivable to cash promptly. The slow collection process of accounts receivable can be a danger signal that a poor job of screening accounts and granting credit has taken place.

6. Inability to convert inventory to cash promptly. A slow down in inventory may signal a problem in the quality of products shipped.

7. Cash tied-up in nonproductive assets. Investing heavily in a new office building, equipment and personnel without careful planning can be a nonproductive use of assets and can destroy a company.

8. Amounts owed to vendors. When an organization is unable to meet the payment terms of their vendors, not only does a serious cash-flow situation exist, the future credibility of the company is in doubt. Long-term business success depends on the goodwill a company is able to generate with its creditors.

9. Low employee morale. Most employees truly want their organization to be successful. When a company is without solid direction, morale declines and with it goes productivity.

In today’s economic climate, if any of these ring true with your business, it is time to take swift action.

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In 30 years of consulting with businesses, this is a common problem aired by most business owners. Smart business owners are frustrated because they are not making the progress they want personally. Not making the money they should, not seeing the growth in their business and not seeing their largest personal asset improve in value.  There are two primary causes of this, this article is going to speak to the first and next week’s article will deal with the second.

The most common problem business owners have is not understanding and utilizing the key performance indicators that monitor the performance of their business.  Not one of you reading this article would take a long trip in your car without looking at the cash gage or viewing the speedometer periodically to pace yourself against the posted speed limit.  The best performance indicators of a company are accurate and timely financial statements (profit and loss statements, balance sheet and statement of cash flow).  But less than 30% of business owners take advantage of this resource.

Let’s quickly discuss what understanding monthly financial statements will do for the owner of a business:

1. It is a report card on the performance of management that everybody outside of the business uses.
2. Bank and other lenders place a major portion of their decision making on the performance of the business as stated by the financial statements.
3. Vendors and other creditors will rely on financial statements to make key credit decisions.
4. Investors will strongly rely on the financial information from the company to determine if they should make the investment or not.
5. The government relies on them to assess taxes.
6. Purchasers of businesses will rely on financial information to decide if they want to purchase and how much they will spend for the business.
7. It is a tool to tell you, as the manager/owner of the business if you are on the right track in attaining your company and personal financial goals and objectives.

Financial statements provide the reference point for you as a manager to guide your company.  I believe that accurately prepared financial statements reflect all the activities in the business: employee satisfaction, product quality, on-time delivery, customer satisfaction, and all of the key financial indicators: revenue, margins, profit, cash flow and upside potential.

Most businesses leave thousands of dollars on the table every year in loss profitability because they don’t use financial statements as a management tool.

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Historically, being a contractor is a great vocation and a productive way to make a great deal of money.  Although 2008 and 2009 were not great years for contractors, predictions are that 2010 and 2011 are going to be much stronger than the last 24 months.  How do you capitalize on that opportunity?

I am a believer in copying things that work and after 30 years of working with business owners, those that have the most money, least amount of debt and stress are the contractors that focus their attention on the bottom line. Yes, making profit, month after month, quarter after quarter and year after year.  They use every method they can to insure that the actions they take every day will make them money.

Want to your spouse to see big pay checks – focus on profit.  Want your kids to have a good education – focus on profit. Want to retire early and wealthy – focus on profit.  Want your banker to loan you money when you need it – focus on profit.  Want to have cash liquidity when you need it – focus on profit.

One of the tools used by successful contractors as a way to manage the performance of their business is their monthly financial statements.  They not only tell if the company was profitable for that month; but also if the company wasn’t profitable, why it wasn’t profitable.  Was revenue lower than expected, margins off or expenses high?  Information is powerful and with current and accurate information, the contractor can be successful.

Where the contractor gets into trouble is when he shoots from the hip and makes a decision without good data.  The contractor wouldn’t be caught dead on a job site without a tape measure. Financial statements are the business’s tape measure.   When the profit and loss statement shows profitability, money will be flowing freely.  When the company doesn’t show a profit, management will always be struggling with having enough cash to operate their business.

Here are six benchmarking tools you can use to determine if your company is on the right path from a financial performance measurement standpoint.  This information was cleaned from a hundreds of other contracting companies as of January 2010.

• Gross profit margins 45% of 50% of revenue
• Net profit 5% to 9% of revenue
• Outstanding accounts receivable – 22 days to 35 days
• Outstanding accounts payable – 29 to 35 days
• Debt to equity ratio 1.6 to 2.9 to 1
• Sales per full time employee $81,000 to $112,000 per year

The financial management function for most contractors consists of looking at the outstanding unpaid bills, outstanding invoices and seeing how much money is in the check book. Most contractors stagnate at revenue levels over $1 million because the check book method of financial management doesn’t work.

The bottom line. When you invest a little time and money into a good financial accounting system with job costing and get some one with experience to enter the data and print reports, you will be ahead of 70% of your competitors.  They don’t know when they are loosing money.  Only the strong survive in any business.  Will it be you or your competitor?  You get to decide.

Questions? Get with me. Want to add to this list? What are your thoughts?

John said that since late last fall, his banker has been very concerned about his company’s ability to make a profit by year end and now, since he hadn’t, his banker was demanding more information on a more frequent basis.  John didn’t understand what all of the fuss was about.  The company was not profitable and probably wouldn’t be profitable until the economy turn around.  John had been through these down turns before and always came out of them, what made this one different?

The story behind the story.  What John didn’t realize was his banker had been reviewing the company’s financial statements for the last 9 months and it shows that although the company had met payroll, payroll taxes and bank payments, it was getting further and further behind with its payments to its vendors.  The company lost $400,000 last year and accounts payable had increased $490,000 in the same period.  The vendors had paid for the $400,000 in losses and also picked up the $90,000 in principal payments the company had paid down on their term debt.

So why was the banker so concerned about the company’s ability to make a profit and John wasn’t so concerned.

1. John had not understood that profitability (one of the key elements of cash flow) is the grease that keeps the business running.  John feels that if he has enough determination, worked hard enough and is committed to his business, everything will work out.
2. John’s banker was more in tune with the financial viability of the company than John is.  This is a bad sign – that your banker knows more about the internal financial workings of the company than the owner does.  The banker is trained to glean minuet pieces of key information from the financial data.  John doesn’t have the background or experience to understand his financial data like his banker does.
3. John was relying more on the past than on the future.  John had been through these down turns before, they always came back and he always made it through them.  Except this time, he is more leveraged than the last down turn and this time it is taking much longer for the economy to turn around than any of the previous 20 years John has managed the company.

In this case, the banker was right to point out to John his concern about the company’s profitability.  Here are six (6) reasons why business owners need to keep their focus on profitability: Profit is the primary ingredient in cash flow (EBIDTA).  It is the “E” in EBIDTA :Cash flow generated from the business is what pays debt service on term debt: vehicles, equipment, real estate, etc.  Want to be debt free – profit is the only thing that will get you there.

• Profit is what builds equity.  Growth in equity is what enables the company to grow.  Revenue growth creates an expansion in assets which forces an increase in the other side of the balance sheet Liabilities and Equity, Liabilities expansion has limitations based on that relationship with Equity.  Want to grow your business, equity has to grow and profit is the biggest contributor to equity.

• Profit is one of the primary elements in value.  Profit has a 3 to 8 times multiplier, which adds directly to value and is the biggest contributor to a company’s value.  Thinking of exiting soon – profit will make you the most take home money.

• Profit builds working capital which enables the company to pay bills in a timely manner and take discount.

• Profit is one of the primary elements that support additional term and working capital debt.  Want to grow your business and need financing, increase your profits and financing is sure to follow.

Profit aren’t everything, they are the only thing.  Profits are critically important to every business.  John won’t be around long if he doesn’t take the steps he needs to get his company showing a profit.  His vendors are going to clamp down on allowing him purchase materials on credit.  Then the pendulum will swing the other way, COD.  No 30, 60 or 90 days to pay, it is pay in advance.  That really puts a crimp in cash flow.

Much of what I do with clients revolves around these concepts in some way. While I have always preached how critical it is to set goals and march toward them, being a sounding board, confidant, and accountability partner is just as important. If you need help in any of these areas, please contact me today!

One of the more significant challenges of owning a business is having enough cash to pay the bills.  Your ability to pay your bills on time, to a large effect, is based on how successful you are in collecting your accounts receivable in a timely manner.

Companies we have worked with who had problems with collecting their accounts receivable have seen dramatic improvement when they followed these few principals.  They may be just what you need to get that cash out of the bush and into your hand.

1. Implement a procedure in your organization where you or someone you appoint is systematically responsible for getting the invoices out in a timely manner. It doesn’t help cash flow if the end-of-the-month billing is not mailed until the middle of the following month. Many customers take 15 to 45 days from the date they receive the invoice to make their payment.  If you get your invoice out late, it just adds that much more time before you receive the money.
2. Always put the current date on the invoice. Many times the customers get a number of bills and they pile up until there is cash to pay them.  If your invoice is not dated, the customer assumes that they just received it and places it with the invoices just received.
3. Put the term of the sale on the invoice. The customer will probably not remember your verbal agreement or may have misplaced the written agreement.  If there is not a reminder on the invoice of when the money is due, you always end up at the end of the line.
4. Establish an accountability system for follow-up on overdue accounts receivable. If someone is not in charge, believe me, no one will take the responsibility of collecting that past due money.
5. Have your accountant or bookkeeper prepare a written aging of accounts receivable at the end of each month, so that you know what is collected and what is outstanding. This report needs to be circulated to the appropriate people at least once a month.  Increase the frequency of preparing this report and distribute it weekly if the monthly method is not effective.
6. Depending on your industry, there is normally a standard for how your customers pay their bills. If a customer exceeds that time frame, either follow up with a nice letter or a personal phone call. There is no need to get aggressive with the first contact.  In that contact, see if the customer received the invoice and if it is in their system to be paid.  Flag your calendar based on their response, and follow up (if no payment) and get another commitment for payment.  Follow this process until the account is paid in full or becomes 90 days old (or the date your have predetermined by your collection policy).  At that point, send a letter indicating that the bill will be sent to the collection agency if arrangements are not made by a specific date (usually 10 days from your current date).  If the amount is large, try to get a face to face meeting with the pay due customer.  In that meeting try to work out payment terms or a trade for product or service.  If that does not work, assign it to a local collection agency or attorney for collection.  Courtesy and consistency have worked the best for me, maybe it will for you, too.
7. If, for some reason, you want to speed up collections because you need an injection of money for a specific purpose, give a freebie. In the radio business, a station could easily give a few spots away if the customer paid their current bill within 15 days when the normal is 30 or 45 days.

Have any questions? Let me know. I’d be more than happy to sit down with you to talk about other ways we can help improve your business cash flow.

Obviously, statistical comparisons help us determine how well we are doing.  They are the measuring sticks of life.  Businesses use them, governments use them, churches use them, non-profit organizations use them.  In business, the most widely used statistic is the financial statement.

Financial statements are the measuring sticks for success or failure in business.  Smart managers know this and are able to make good use of the information found on a financial statement.

Within a company, financial statements are the most accurate record of performance and are, therefore, one of the most helpful management tools—if used correctly.  Financial statements can help management determine if profit targets are being met, if cash flow is adequate, or if long-range objectives are being achieved on time.  They provide a backbone for predicting the future.  In short, when management uses monthly financial statements as a resource and tool, it can usually foresee or even prevent the company’s failure.

THE BALANCE SHEET

The most important element of a financial statement is the balance sheet.  The balance sheet provides a picture—a literal snapshot—of the financial condition at a given time in a company’s history.

A balance sheet is better understood by focusing on the “balance” idea.  It has three components:  one on the left side of the fulcrum and two on the right side.  The component on the left side is called “assets,” the total funds invested in the business.  The two components on the right side are “liabilities” and “capital.”

Liabilities are the funds supplied to the business by its creditors.  Capital is the funds supplied to the business by its owners.  The assets side should always be in balance with the liabilities and capital.  For example, when product is purchased for resale, inventory increases on the assets side of the balance sheet and accounts payable increases on the liability side.

The balance sheet has been standardized by the accounting profession to contain mostly the same categories.  You can pick up a balance sheet from General Motors and one from your local grocer and both will have assets, liabilities and capital.

The assets on a balance sheet are arranged in decreasing order, depending on how quickly they can be turned into cash (liquidity).  That is why cash is always first, accounts receivable second, inventory third and so on.  The liabilities are listed in order of how soon they must be repaid.  Accounts payable usually top the list, followed by other payables, taxes payable, bank note payable, mortgages, etc.  Capital is defined by a number of categories depicting the type of funds that are invested by the owners of stockholders.

YOUR FINANCIAL BALANCE

The balance sheet is an excellent management tool for keeping you in touch with the financial balance or financial imbalance of your business or organization.  This financial balance has crucial cash flow and profit implications that can greatly benefit or hinder the businessman.

Entrepreneurs usually start their companies with a relatively small amount of money, usually not enough.  The overwhelming share of owner’s equity though, comes from a powerful source—retained earnings.  During the history of the business, there needs to be a reasonable balance between the proportion of owners’ (stockholders) money in the business (capital) and other peoples’ money (liabilities).  There isn’t a precise, scientifically derived cutoff point between financial balance and financial imbalance.  But there is an approximate point, and its impact is real and immediate.

The best way to determine this point is with the “debt-to-worth ratio.”  It measures the relationship between liabilities (other peoples’ money) and capital (owners/stockholders’ money).  This ratio is calculated by dividing the total liabilities by the total equity (common stock, plus retained earnings, plus current year earnings).  For example, if the company has $350,000 in liabilities and $100,000 in capital, it has 3.5 to 1 debt-to-equity (capital) ratio.  This means for every $1 the owners have invested in the business, the other people have $3.50 loaned to the business.

Determining the adequacy or inadequacy of this debt-to-worth relationship is not simple and is based on the historical performance of the company, the type of industry, the owner’s own capital and the concrete prospects the company has for profitable operation in the immediate future,  For most closely held businesses, the ratio should be somewhere between 4.0 to 1 and 1.5 to 1.  A business that has maintained consistent profitability over the last few years can have a higher debt to worth ratio than a business that has erratic or low profitability.

The balance sheet is also a great source of information when determining how to increase a business’ cash flow.  The effective use of all assets—accounts receivable, inventory and fixed assets—is paramount to maximizing available money.  With detailed information from the balance sheet and a profit and loss statement, a business can measure the effectiveness of its investment in the key assets that directly affect its cash flow.

OTHER WAYS TO ANALYZE

Before using your balance sheet to pinpoint additional problems, gather up your last three years of financial statements and a projected year-end balance sheet for the current year.  Then take the following three steps:

1. Calculate the debt-to-worth ratio for each year and determine whether the ratio is getting bigger or smaller.  If bigger, figure out why and make some changes to correct the problem.  It needs to be getting smaller.
2. Review your investment in accounts receivable.  Is the investment in this asset growing at the same rate as sales?  Slower?  Faster?  Retailers won’t have a  heavy investment in accounts receivable, but for those businesses that do, a faster growth in accounts receivable as compared with sales will deplete cash flow.
3. Review your investment in inventory.  For businesses in retail or wholesale, this will be a key line item to review.  As with accounts receivable, the amount of inventory on hand needs to relate directly to sales.  If sales in the business have been growing at a rate of 12 percent over the last three years, at what rate has the investment in inventory been growing?  If the investment in inventory is growing much faster than the growth of sales, this will negatively affect cash flow.  If it has been growing slower than sales,  it could positively affect cash flow.

REVERSING PROBLEMS EARLY

To ignore the information available on a balance sheet is detrimental to a businesses financial health.  Many of these problems can be reversed early enough by analyzing financial statements.  For entrepreneurs to be able to manage the financial balance of their own business, they will have to be able to analyze their own financial statements and be able to evaluate those figures in light of some good business planning.