Look at any small business’s financial statements and you’ll find that it includes a balance sheet. A balance sheet is the place where you lay out your assets and liabilities in one document and see a snapshot of your small business’s finances at a given point in time.
But is this stuff really useful? I’m not so sure. Of course, regularly preparing a balance sheet is not only required by accounting standards but also can prove to be a valuable exercise: It gives you, the business owner, a chance to list out your assets and liabilities, which offers your banker and your investors at least some idea—a vague idea—of your company’s net worth.
But be warned: Don’t for a minute think that your balance sheet is portraying the whole picture of your small business’s health. In my opinion, it’s not. Why? For starters, and as mentioned above, it’s just snapshot of a point of time in the past.
Sometimes, that “past” can be a very long time ago. Publicly held companies file their quarterly financial statements with the Securities and Exchange Commission anytime from 40 to 45 days after their quarter ends—a lifetime in the eyes of most shareholders. And that’s for publicly held companies, which are generally considered to have more advanced financial reporting systems than the typical small business owner has.
Most small businesses prepare their financial statements annually, and usually for the purposes of filing their tax returns. Others that rely on their accounting software applications can generate financial data more frequently but—at least in the case of most of my clients—with less accuracy until their accountant makes adjustments. By the time your balance sheet is cleaned up and blessed by your accountant, the data is simply out of date.
Unfortunately, the data isn’t really that accurate, either.
That’s because generally accepted accounting principles require that most assets and liabilities are recorded at “cost” or “book value.” This may be fine for some assets, like cash or current accounts receivable, and accounts payable. But ask anyone who values businesses and they’ll tell you that many of the items on a balance sheet need to be adjusted to better represent the market:
- For example, you may have paid $100 for a piece of inventory earlier this year or $25,000 for a machine you bought five years ago. What are those assets really worth today? What would the market pay for them?
- Or say you owe the bank or a vendor $100,000 that’s payable over the next five years. What’s the true value of that liability in real dollars based on today and future interest rates?
- And what about intangible assets, like licenses, patents, or trademarks? These assets are also carried at cost, which can be significantly below what they’re really worth to a potential investor.
Whenever I have a client who’s selling their business, a full revaluation of their balance sheet needs to be undertaken to better reflect the market value of all the assets and liabilities on it. If you’re not doing that regularly—and who does, really?—then your balance sheet is giving you an inaccurate representation of what your small business is truly worth.
Finally, balance sheets leave too many things out. Don’t believe me? Ask any investor where they turn first when a company releases their financial statements, and most will tell you that they go straight to the footnotes.
That’s because the notes to a company’s financial statements reveal a lot more information than what’s in the balance sheet (and other statements). You’ll find out about liabilities—leases, commitments, potential lawsuits—that haven’t been reflected. You’ll learn that, although accounts receivable looks strong at first, those balances could be made up of only a few significant customers, with any one of them having the potential to cause a major disruption if unpaid. You’ll find out how inventory and other assets are truly valued (LIFO? FIFO?) and whether or not that methodology actually makes sense in the real world of buying and selling.
And what about the value of really important things—like a store’s location, a potential new customer contract that will very likely take effect in the future, or the recent hiring of a star employee with special skills? You won’t find those assets on a balance sheet. Most importantly, the balance sheet doesn’t include an item that’s critical for any potential investor: goodwill. That’s the price an investor would pay over and above the net worth of the company, and it’s based on the future value of all the aforementioned things and others.
Of course, a balance sheet does provide some pertinent information about your small business that you may find useful. But, if you really want to manage your business the right way, you should be focusing more on daily and weekly metrics—sales, payroll, margins, and product and job profits—that give you a much better picture of how your small business is doing.
Next Steps: You’re busy. We get it. So why not let us do some work for you? By signing up for the weekly Small Biz Ahead Newsletter, you’ll receive hand-picked articles, How-Tos and videos covering the latest in small biz tools and trends. We’ll do the research while you spend your time where it counts: managing and growing your business.