As we all know, financials are the ultimate scorecard in business, telling us exactly how well we’re doing and where we need to improve or tighten up.
That’s why we work diligently with all our ACE Peer Group members to measure and manage their key financial metrics. Often owners focus on their profit-and-loss statements while overlooking all the meaningful metrics that can be found in their balance sheets.
Now it’s true that your P&L statement can provide you with critical insight into your business. It can tell you how well you’re doing compared to your budget. It can tell you how you compare to where you were at the same time last year. And it can tell you how much you made last month.
But your P&L can really only tell you what you have done in the past—it can’t tell you much about the future, or if you’re going to be able to meet payroll this week. To figure that out, and to gain a fuller picture of your financial health, you need to look at your balance sheet.
What to Focus On First
Your balance sheet shows how much wealth you are building in your company. It’s divided into three sections:
Assets, or what you own.
Liabilities, or what you owe.
Equities, or what your business is worth.
We will dive farther into this subject in future Great Ideas, but to start, take a look at your balance sheet this week and ask yourself these three key questions:
How much cash (on average) do you have in the bank? A good rule of thumb is always to keep at least 2.5x your average payroll.
How much total debt are you carrying compared to your equity? To calculate this, take your total liabilities and divide that number by your shareholders’ equity. Anything more than 2 is considered too highly leveraged.
What’s your current financial ratio today? Many owners refer to this as their “current position,” and it’s one of the first things a bank will look at when evaluating your company’s health. It’s called “current” because, unlike some other liquidity ratios, it incorporates all current assets and liabilities. To calculate yours, take your current assets and divide them by your current liabilities. You want the result to be above 1, meaning your current assets outweigh your current liabilities.
Again, these questions are just a start, but your answers are an important step to securing your company’s future. As we often remind our ACEs, in business what gets measured gets improved.
Have a great week!
The MGI Team