Balance Sheets for Small Business

One of the major differences I found between public accounting and private accounting is the actual “attention to detail” required in private accounting.  My day actually began by updating and reviewing the dashboard – which focused on the primary accounts and the transactions that made up the changes from the day before.  There were only three primary balance sheet accounts that I focused on daily and I will explain why below.

The Balance Sheet for Small Business

These three accounts represent the assets and liabilities that the business actually controls.  That doesn’t mean that the other balance sheet accounts are not important – they are – but that they are what I term “accountant controlled” meaning that the account exists because the accountant believes it helps in understanding the Company’s assets and liabilities.  The three key accounts for a small business owner to follow are Cash, Accounts Receivable (A/R) and Accounts Payable (A/P).

Cash

To steal a phrase, “Cash is King” and cash is very important in a small business.  It is the one asset that small business owners cannot get enough of and it can drive every decision.  Often our management meetings started with the question, “How much cash is in the bank?”  It is also the one account where we have a good independent record of the balance – the bank statement.  And with the ability to log in to the bank’s website and look at the balance and recent transactions, the small business owner has an unprecedented ability to know where the cash balance is daily.

Trying to run the business only on the balances in cash can be dangerous though.  For instance, having $100,000 in the bank: What does that tell us?  Some business owners are worried when cash is that low and other small business owners rejoice.  So, for every management meeting I answered the question of “How much cash is in the bank?” by linking the cash to the next two accounts.

Accounts Payable

Accounts payable (A/P) is a measure of what the small business owes vendors for the all goods and services purchased and that haven’t been paid for yet.  A small business gets the privilege of having an A/P balance by paying their vendors on their terms.  Moving from cash/COD/Credit Card payment to net30 day terms is a major milestone for a small business as it means the vendor trusts the business to buy today and pay later.

To continue the example above, if cash is $100,000 and accounts payable is $20,000, my answer to the question, “How much cash is in the bank?” is “We have $80,000 available today.”  The owner and management team need to understand that the A/P is a claim on the cash and ignoring it can lead to big problems when vendors put the Company on credit hold for not living up to their promise.  I looked at accounting’s role as “Keeping the promises that the sales professionals made” and we purchased goods and services on terms for the sales team to sell to customers.  You should never let the promise go unfulfilled.

Accounts Receivable

Accounts receivable (A/R) is exactly like A/P but for the benefit of the customer.  At some point, especially in business-to-business (B2B) transactions, there is an expectation that the customer can buy on some customer-friendly term such as Net 30.  It is a trust relationship between the small business and the customer and it is important that the small business manage this trust relationship.  Selling on terms can get you access to new customers but can lead to failed commitments from the customer.  This, sadly, is a fact of business but the potential for loss should not keep the small business from selling on fair terms.

Continuing the example, if cash is $100,000, A/P is $80,000 and A/R is $100,000, how is the question answered?  My answer would be, “The Company has $70,000 available.” Why would I answer that way?  Because of the experience of many years in public and private accounting.  Below is how I come up to the answer.

The Company will want to keep its promise to the vendors and pay on terms.  So the company plans to pay out $80,000 – leaving $20,000 in the bank.

The Company wants to believe that all its customers follow this same pattern – that terms are important and they want to honor them.  We want to believe that all of the $100,000 due from customers will be paid in the next 30 days.  But the reality is that some will be late.  So, to ensure that the Company does not make plans or promises it cannot keep, the safe and conservative approach is to say only 1/2 will be collected, or $50,000.  The $50,000 plus the $20,000 equals the $70,000 of cash available for the business.

Back to Cash

Knowing how much cash is available allows the small business owner to make more effective decisions.  If payroll is $90,000 over the next 30 days, the business may need to draw on the Line of Credit.  By starting with cash and then subtracting the Company’s promises (A/P) and adding in a reasonable amount of the customer’s promises (A/R) the business owner can start making better decisions about how business gets done.

If you would like more information on how to get clarity on your accounting, feel free to contact me or visit our website.  We will be happy to email you our free guide to “Five Important Things Business Owners Need to Know about Financial Statements” to help you understand what Bankers think about when they review your financial statements.

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