01 Nov Is Cash Really King? Why Cash isn’t the Best Barometer of your Business Health
As a business owner myself, I understand why our clients want to know how much cash they have during our post bookkeeping work meetings. Cash is King, right? Cash is certainly important since no business can survive without a healthy cash flow, but cash doesn’t tell the whole story. To see your true business health we need to look at the entire Balance Sheet.
Before we can understand why a balance sheet shows the health of your business it is important to be able to read a balance sheet properly. Your company’s balance sheet is the story of what your company owns, owes and the net profit or loss kept in the business. Let’s review each section.
What your company owns, or the Asset section of the balance sheet, lists all the assets of the company including cash on hand, bank accounts, accounts receivable, inventory, fixed assets (like furniture, equipment, vehicles, buildings, etc) less depreciation, loans receivable, security deposits….everything a company owns and/or is owed from others.
What your company owes, or the Liability section of the balance sheet, includes accounts payable, credit card debt, short-term and long-term loans, payroll taxes payable, sales tax payable, pension expense payable and any other monies owed.
What profits or losses your company kept in the business is the Equity section of the balance sheet. This section includes capital stock (if a corporation), Shareholder or Partner equity accounts (past earnings less monies distributed to partners or owners), and current year earnings.
So how do these three sections tell the reader the health of your business?
Take two scenarios. The first is a business with an abundance of cash available, and the second is a business that has significantly less cash.
In the first scenario, a business has an abundance of cash available. At first glance that would seem to be a great financial position and good indicator of business health. But in looking at the rest of the asset section there are no additional assets – no Accounts Receivable, loan receivables, no fixed assets. No worries – plenty of cash is still great. But wait, in looking at the Liability section (what the company owes) there is also an abundance of accounts payable, loan payables, sales tax payable, payroll tax payable totaling far beyond the amount of cash the business owns. So even though there is a lot of cash it isn’t adequate to cover the monies owed and indicates poor health of the business.
Also, the equity sections shows little to no retained earnings or partners’ capital. This could be because the owners have distributed all the past profits or the company did not make any money in the past (that is where the Income Statement or Profit and Loss statement tell the rest of the story). Whatever the cause we know for certain that it has depleted the capital reserves of the business.
A reader (a bank, investor, owner, etc) of the balance sheet would be able to determine that the continued success of this business is in jeopardy!
Scenario two tells a different story. Although there is less cash in the bank, there are other assets as well – accounts receivable with no accounts due over 30 days, fixed assets, and a loan receivable that has been collecting regular monthly payments. The good news continues in the Liability section with a small credit card balance and no sales tax, payroll tax or accounts payable due. In this case, the current assets – cash and accounts receivable can more than pay their current liabilities. Also, their equity section indicates a strong retained earnings number.
A reader of this balance sheet would give the business a good bill of health!
So is cash King? Well, yes! But it isn’t an indicator of a business’ financial health. You would need to see the entire balance sheet to be sure.
Timely, reliable, and accurate financial statements are important part of your business success. TBooks helps small business owners succeed by providing Bookkeeping, Accounting and QuickBooks services that enable you to:
- Understand your Books & Business Performance
- Spend More Time Growing Your Business
- Make More Informed Decisions
- Increase Profit and Cash Flow
- Decrease Tax Liabilities
Contact us today for a free review!
No Comments