The Balance Sheet is a financial statement that gives the user a snapshot of how much the company's assets, liabilities, and owner's equity are worth. It tells us if a business has a "going concern" which is an accounting term for a company that is financially stable enough to pay its debts and continue for the foreseeable future.
If the Balance Sheet determines the financial health of a business, then a regular review of this financial statement should be implemented in your monthly financial analysis.
With my clients, I use a variance analysis, plus a monthly trend analysis of the Balance Sheet to determine the overall health of the company.
How To Review The Balance Sheet
With a Balance Sheet Variance Analysis, I am looking at the difference between a current period and a prior period to see what the assets, liabilities, and equity are doing over a period of time.
Below is a variance analysis of one of my client's financials. This particular person has a lot of different types of assets and very little liabilities. With this scenario, I am focusing on how the assets are moving and if I am able to explain why. If I am able to do that, my understanding of how to guide my client appears through the information. Secondly, I know my accounting is correct.
Take a look at how the cash is moving. Between 10-22 and 10-23, cash went down by 46%.
We also see that the marketable securities are being drained between the two time periods by dropping 83%!
What you don't see is the long term assets section of the Balance Sheet which would show you where those current assets are going. The real estate section of the Balance Sheet increased by the amount of the decrease in current assets.
Using this review tool in your accounting can help add a layer of understanding as to what is happening with your business.
A monthly trend analysis looks at the direction the Balance Sheet elements are taking.
For example, are current assets going down while current liabilities are going up? This would lead me to believe that revenue is trending downward, which I could verify on the Profit & Loss.
Below is a monthly Balance Sheet where you can see how the monthly numbers are moving.
In this financial review method, I am looking to see if there are any irregularities on a month to month basis and also seeing what the total value is and how it relates to the prior months.
In the example below, we can see that cash popped up in July, from $64k to $111.6k. The question I should ask myself is; what happened? It is explainable as we can see that Accounts Receivable dropped significantly which, in this case, meant that the cash came into the bank.
How about irregularities? Notice the negative receivable in July of ($1.2k)? That should trigger me to look into why it's negative. An easy check showed me that one customer has a pretty hefty credit on his account and the other large receivables were paid off in that same month.
Overall, assets have flatlined through the last six months which tells me that the business is not making a ton of profit.
But what we also see is a transition in the type of assets being used. Cash is moving to a fixed asset that will end up creating more revenue so that overall assets go up even if the business is currently breaking even on the Profit & Loss.
Liabilities should be looked at also to make sure that the business is not ramping up liabilities without some kind of beneficial purpose.
The final financial review of the Balance Sheet that I do for my clients is with the Current Ratio. This ratio reveals how financially stable the company truly is.
The Current Ratio is calculated by dividing the Current Assets by the Current Liabilities. Generally, we want to see this ratio at 2 or above.
Although you can't see the liabilities in the example, the Current Ratio has went from 2.3 down to 2.1 over the course of the last six months. The reason being was that the client had to take out a loan to help add capital to the asset being built which means that the decrease is explained and actually going to benefit the business in the longer term.
If you don't review your Balance Sheet, it will be very difficult to know if you are headed in the right direction in financial stability! The issue is that some people don't have the time to dive into the details. If you find that is your case, please feel free to reach out as I may be able to provide some help.
Blue Collar CFO