Using balance sheets and analysis to your advantage

Almost every football coach will tell you that the team that controls the ball is likely to win the game. Well, your business is the ball and you need to control it — not vice-versa. If I asked whether you’d welcome and actually use all the available financial information your company could muster before making an important financial decision, you would likely answer, “Heck, yes. That’s the dumbest thing I ever heard.” Why is it, then, that I see business owners making decisions every day without consulting the best source of information they have — their company’s own financial statements?

Most business owners don’t get statements for management purposes. They get them as a result of having to report income and expenses for tax purposes, or to satisfy their banker. You get your year-end statement and glance at the income statement, eyes immediately going to the bottom line. If there’s no “red ink” and no big tax to pay, you heave a big sigh of relief, assume it’s OK for another year and toss those statements in the bottom left-hand drawer to gather dust with all the others.

This is all the more surprising — and deadly — when you realize that all financial management begins and ends with those statements. Your company’s strategic plans and operating decisions ultimately boil down to a picture of your business that’s measured in dollars and cents. That’s what financial statements are all about.

So, from a financial perspective, we’re all in the same business and it’s called money management. In your case, you rent and sell things that others need. In the final analysis, however — whatever your product, service or trade — all those contrasting activities end up in someone's financial statement either as a plus in the profit column or a minus in the loss column. One permits survival. The other does not, at least not for long.

If all of this is true — and if the clues to future success or failure are chronicled in these financial statements for anyone with eyes to see — then why don’t supposedly astute decision-makers read them?

Is it because they don’t know how to read a statement or interpret it properly? That makes them like the ship’s captain who can't decipher a nautical map — I’d just as soon not be on that ship and neither would your banker.

Or is it because financial statements are records of past performance and “go-get-em” entrepreneurs think only about the present and worry about the
future, and therefore reading statements is judged to be a waste of time? Isn’t that a little like buying a baseball team and planning for an immediate pennant without first studying the team’s record in prior seasons and assessing its current strengths and weaknesses?

There are two most important elements of financial statements — the balance sheet and the income statement.

These elements are virtually worthless to you as effective management tools unless they are well-prepared, accurate and current. This clearly puts the burden on your accountant, who, if the person is really earning their keep, must supply you with up-to-date financial facts in a language you can understand.

While you’re at it, why not also insist that these well-paid-for reports arrive when they can do you the most good? In our fast-paced economy where the planning time is continually shrinking and change is continually accelerating, obsolete figures in months-old statements are not useful.

Timeliness is important from another aspect, as well. Since all numbers — especially on the balance sheet — are recorded at historical cost, they can all be distorted by forces such as inflation or deflation. In many cases, the original cost doesn’t reflect the current market value of many assets or liabilities. Obsolete inventories and real estate purchased at inflated costs are all overvalued. The accounting profession is taking steps to resolve these problems, however you need to be aware of them, no matter how late your financial statements arrive.

The person with the most responsibility for shortcomings in using financial statements is usually you. You keep your records in a shoe box or a gunny sack. You only get statements to figure out how much tax you don’t have to pay. The accounting systems in many businesses I see conceal rather than reveal information. You perversely figure that if you don’t know what the heck is going on, neither will the tax man. This is wrong and they will “help” you straighten things out.

On the other hand, maybe you keep more than one set of books or records. This might sound fishy, but keep in mind that the first two sets — one for the tax man and one for you — are common and even preferred. The rub is that “creative” bookkeeping can obscure the real picture. Never forget that the worst possible person to kid is yourself. Remember “GIGO” — garbage in, garbage out. Your results and the usefulness of your information are only as good as your record keeping system.

Keep in mind that financial statements, even with all their shortcomings, are an indispensable management tool. Taken together, the balance sheet and income statement represent as reasonably complete a picture of a firm’s financial status as you’re going to get. Your challenge is to monitor them consistently and interpret them accurately.

This is exactly the same process your financial advisors go through and there’s no magic to it. I see far too many business owners who wait until the end of a year and then ask their advisors “How did I do?” By then, it’s too late. You need to know the answer throughout the year.

One way to do this is to assemble your financial data for three or four years. Transfer all of these balance sheet and income statement figures to a spread sheet, which is merely a method of laying out several years of financial data in an easy-to-compare format. Now, analyze what you have in front of you and look closely for trends.

The heart of every worthwhile financial analysis is the interrelationship of the numbers in the form of ratios and comparing key ratios against both company trends and industry averages. This is not as mysterious as it sounds and it can be enlightening — sometimes disturbingly so — in terms of showing trouble spots.

When you find those trouble spots, half your problems are licked. The other half is solving them, but you can’t solve a problem you don’t know about. Find the trouble spots, solve them and then you are ready to set reasonable goals and objectives for your firm.

In the process, you’ve actually used your financial statements to good advantage. You've read them, analyzed them, interpreted them and made decisions based on them. You will learn something from this process, however it can’t be guaranteed whether what you learn is good or bad news.

Your primary responsibility as a business owner is to make prudent and well-informed financial decisions, which will have a major impact on the survival of your firm, its products and its employees. The goal here is simply to add accurate financial data to your own built-in decision process, including “gut” feeling and intuition.

At Business Resource Services (BRS), we call this process performing a “Fiscal Physical®.” As an American Rental Association (ARA) member, you also have the opportunity to join other member businesses in this process by participating in the latest ARA Cost of Doing Business Survey. You send the data to BRS, we do the number crunching and send each survey participant a comprehensive report about the fiscal condition of your company, how you square up to your peers and suggest areas that may need more of your management attention. For details about how to participate, see the story on page 155 of this issue. Cheer up. The journey can be as fascinating as the destination.

Carl Forssen is senior vice president, Business Resource Services (BRS), Seattle, a financial management training and consulting firm with a mission to help closely-held businesses succeed. BRS has worked with ARA and its members for several years to produce the ARA Cost of Doing Business Report, as well as providing practical, applicable, financial management training programs at The Rental Show and other ARA venues. For more information, call 800-488-3520 or visit www.profitmastery-university.com. © BRS 2011.