Ask Us How: What it Means to Have a Clean Balance Sheet

Posted by Michael Derin

Published on October 16, 2013 under NSW Business Chamber Partnership

One of my key goals with the SME’s I work with at present is to ensure they are fully aware of their cashflow obligations and are understanding the importance of having a clean balance sheet to avoid any surprises in the current economic climate.

This may seem like a simple task to most people but in reality a huge proportion of SME businesses fail due to lack of financial management, cashflow problems, under capitalisation at the start, excessive director drawings, overuse of credit, no budgets or inadequate cash provision for taxes.

Therefore my goal in business today is to educate on the importance of not only ensuring a clean balance sheet but on how to manage your cash coming in and flowing out. 

WHAT IS A BALANCE SHEET?

For those of you not familiar with the term “balance sheet” it may be better explained as a financial statement which offers a snapshot of a company's health.  It tells you how much a company owns (its assets), and how much it owes (its liabilities). The difference between what it owns and what it owes is its EQUITY, in simple terms commonly known as “net assets" or "shareholders equity".

The balance sheet tells a lot about a company's financial fundamentals: how much debt the company has, how much it needs to collect from customers (and how fast it does so), how much cash and equivalents it possesses and what kinds of funds the company has generated over time.


WHAT ARE THE BALANCE SHEET’S MAIN COMPONENTS

A balance sheet will carefully analyse a company’s Assets, Liabilities and Equity and can tell a great deal about the company’s financial fundamentals.

A company’s Assets are considered one of the most important elements of a balance sheet, because they represent the business’ cash, inventories and receivables and a balance sheet which represents plenty of cash is always more attractive to investors or bank managers and often indicate strong company performance.

A company’s Liabilities are also imperative to have right from a cashflow perspective because this represents your current and noncurrent liabilities, ie. Management of your debt. 

Any business would want to see this at a manageable level, accounted for in the right months and highly accurate.  Having your liabilities not accounted for correctly could mean the difference between your business surviving or failing in the current economic climate.

A company’s Equity represents what shareholders own, so it is often called shareholder's equity.  Equity is equal to total assets minus total liabilities.


Equity = Total Assets – Total Liabilities

The two important elements to remember in terms of equity items are those paid in capital and those that are retained earnings.  In simple terms - Paid-in capital is the amount of money shareholders paid for their shares when the business was first offered and retained earnings are a tally of the money the company has chosen to reinvest in the business rather than pay to themselves. 

Banks or Investors would look closely at how a company puts retained capital to use and how a company generates a return on it all highlighted through your Balance Sheet.

SUMMARY

In summary these three core elements are significant to how a business “looks” to the public eye.  A clean balance sheet can help you with further funding, raising capital or providing evidence for your bank for various facilities.

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