How One Entrepreneur Discovered a Big Liability Hiding in Her Balance Sheet

The importance of the balance sheet.

Of all the fine details involved in running a business, creating a balance sheet can seem like the worst. Most entrepreneurs understand that their company must remain profitable to survive and grow. But generating and analyzing a comprehensive financial statement is a step that a lot of entrepreneurs skip. The results of skipping this necessary step can be very detrimental to your business, as business mentor and Inc. Magazine contributor Norm Brodsky recently shared.

“Among all the tools entrepreneurs have to monitor what’s going on in their businesses, one of the most important–and least used–is the balance sheet. Most people understand the concept of an income statement, even if they don’t really know how to use one. They’re aware that you won’t last long in business if you’re not consistently earning a profit on whatever it is you sell. A balance sheet, on the other hand, can be confusing, and many don’t understand what it’s for. That can be a problem.”

Norm tells the story of Claire Theobald, founder of Beatrix New York, a company that produces high quality, designer gear for children. Claire’s stylish backpacks, lunchboxes and other products are produced in China, warehoused there and in the United States, where they ship out to numerous countries for sale. When Claire approached Norm for advice, her company was having cash flow problems for reasons unknown. She was looking for help in figuring out why. Norm suggested that they create and take a look at her balance sheet, which she had never done before.

The Beauty of the Balance Sheet

A balance sheet is basically a financial statement that incorporates a company’s assets and liabilities, including items like cash, accounts receivables, inventory, taxes, and accounts payable. It allows you to see snapshots of your company as a whole, spotting potential problems in a way that simple income statements could miss. Norm quickly spotted a couple of big problems with Claire’s company. Her warehouse in China had not sent a bill in over a year. When she finally received the bill, it was through the roof high. It turned out that, unlike the U.S. warehouse that she used, the China warehouse charged by the amount of space used. Claire had recently added kid-sized suitcases to her inventory. They weren’t selling well. She had already put them on sale, but looking at her balance sheet showed that they still weren’t selling quickly enough to justify the warehousing costs.

“We calculated what she spent on storing the suitcases and then shipping them, and the cost was more than they were worth. I suggested she give away the ones in the China warehouse to the workers there. (She did, and they were thrilled.) I also suggested she discount the items on her website, mostly sold in the U.S., by 50 percent. The faster she got rid of them, the more time she would have for other, more productive activities, especially sales. And by doing both, she would simultaneously reduce her costs and generate additional cash.”

Get Comfortable with the Accounting Side of Your Business

In order to determine the true profitability of a company, it’s important to examine all aspects of its operations. Consistent cash flow is certainly the most important factor. But if your company is bleeding money from various expenses, like Claire’s warehousing costs, then you could discover that your business is insolvent despite excellent sales.

“By definition, a company is insolvent when its short-term liabilities exceed its short-term assets. Those assets include inventory and receivables. If you have a lot of old receivables that can’t be collected, or a lot of old inventory that can’t be sold, you could become insolvent, even if you appear to be profitable on your income statement, and insolvency is one step away from bankruptcy.”

Balance sheets may not be one of the more fun aspects of business ownership, but get comfortable with them anyway. Regular analysis should form a cornerstone of your plans to maintain profits and grow your business.

Read Norm Brodsky’s article in its original form at Inc. Magazine’s website.

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