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Keeping Financial Balance Shouldn’t be a High Wire Act

by Hal Levenson on Aug 29, 2015 8:08:17 AM

In 2008, director James Marsh released Man on a Wire.  The documentary chronicled Philippe Petit's 1974 high-wire-walk between NYC's twin towers.  The award winning film showed Petit's courage to take on whhigh_wireat many considered impossible ' and crazy ' while staying true to his convictions. 

Walking on a wire 100+ stories up in downtown New York City is not for everyone.  But understanding how basic 'balancing' works can be and should be for every small business executive.  The surface of your financials are often not what they seem.  Yet, hidden gems can be easily revealed with a good balance sheet.

Let's take a look.  What company would you rather have?

a)    Company A with annual revenues of $5,000,000; annual cash compensation for the owner of $400,000 and an annual net profit of $750,000,

or

b)    Company B with annual revenue of $10,000,000; annual cash compensation for the owner of $400,000 and an annual net profit of $750,000?

On the surface, the answer is Company B! Everyone loves the $10 million in revenue!

But what if we added a few more details that reveal a bit more?  Take a look at the Balance Sheet of the same companies:

 

Company  A

Company B

Cash     

$500,000

$750,000

Account Receivables 

$475,000

$1,475,000

Inventory

$0

$500,000

Fixed Assets

$150,000

$1,000,000

Total Assets

$1,125,000

$3,725,000

Payables

$250,000

$1,500,000

Debt

$50,000

$750,000

Retained Earnings

$825,000

$1,500,000

Total Liabilities & Equity

$1,125,000

$3,725,000

 

Perhaps you'd change your opinion to Company A because it suggests a more sustainable business for several reasons:

  • Less financial risk: This is true both personally and corporate since Company A liabilities are lower overall.  Company B's payables, debt and inventory are fairly hefty suggesting you may have to sign personally on any debt extension needed to help cash flow.  
  • Lower cash flow issues:  Company A's cash position more than covers its payables and debt.  For Company B however, the current cash position could get squeezed if receivables slow as payables come due.  A hiccup in product or service quality often means slower pay by a customer until things are resolved consequently putting pressure on receivables. 
  • Higher Return on Assets: Company A gets $750,000 in profits on $1,125,000 of Total Assets for a 66% return on assets.  Company B gets the same $750,000 in profits on $3,725,000 of Total Assets or 20% return on the assets in the company. Company A is getting a better bang for it's buck because it takes less to generate the same amount of profit.

The bottom line is that you need to look past the surface of basic financials.  The surface is not often what it seems.

Don't get caught looking at only one facet of your company to know how financially strong it is.  This is particularly true when getting tied emotionally to revenue growth.  You must look at the financial risks regarding concentration of customers and vendors, how much additional liabilities you need to take on and potential cash flow risks.

No need for a high wire act but understand how a balance sheet can work for you.

Learn more about the secrets to your financials in our seminar series!

 

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