Learn to Love the Balance Sheet

When I owned a marketing agency, I would set aside time every week to go over the business finances. 99.9% of the time this meant reviewing the P&L.

I would look back at prior months/quarters and say 'nice, that's how much profit we made' and look forward to succeeding months/quarters and say 'how many clients do I need to close to hit these revenue targets?'

I suspect that most business owners & execs think this way. It's fairly easy to wrap your head around if you have any kind of business chops.

Money comes in, expenses go out, profit is left over.

These days however I find myself first reaching for the balance sheet when reviewing company finances. I look at the P&L last.

Why?

The balance sheet is the foundation of strength in a business.

Through the lens of the balance sheet it's easy to see the range of moves that can be made in the short- to medium-term, and the risk profile of such strategies.

Heavy cash creates options, strengthens against downturns & weak revenue performance. Low/no cash & it's code red.

Inventory levels tell you what's feasible in the coming months/quarters for revenue.

Hard assets give you accounting tools for tax, financing, etc. And a sound reference point for checking the flow on the factory floor & planning more equipment purchases.

Short term loans, credit cards, lines of credit narrow your strategic options & add pressure if they are tapped out. Net of cash, they may represent a cashflow black hole that must be overcome. On the other hand, available & untapped lines expand options and remove pressure. Keeping in mind the absence of such a thing is, in itself, a state of affairs.

AP of various flavors shows you where stress - or strength - lies with the biz cost structure depending on negotiated terms. And terms reveal themselves through AP balances.

Long term loans do the same as short term loans, but with long term flavor. And complete the overall picture of net equity and leverage in the business.

Some things are obvious and immediate when you assess a balance sheet:

• Cash, is there a lot or a little? Just enough?
• Are the credit cards & lines of credit maxed out?
• How much in PPP loans are sitting around from the covid days at 3%? Which do, of course, need to be paid back eventually but will likely linger on the balance sheet for a long, long time.

Other things derive as second order insights tied to the P&L:

• Does the rev forecast make sense with inventory levels, inventory in progress at the factory, etc.?
• Can we afford that new machine?
• How many people can we hire?
• How aggressive can we push pricing? Esp. without risking a cash crunch?

These are the things that give color to the P&L.

And so it is for these reasons and more that I like to say these days: learn to love the balance sheet.