The most fundamental rule of navigation is:
“You must know where you are before you know which way to go.”
Sometimes it may seem obvious which way to go but without knowing your real position how do you know if you are heading in the right direction? Picture yourself sailing along in the Pacific on your way to Hawaii. If you thought you were just east of the islands it would make sense to sail west to get there. But if you had unknowingly sailed past the islands in the night, while sailing west you would have thousands miles of open ocean before you hit land. You would be wasting a lot of time and risking your life because you simply didn’t really know where you were before continuing on your course.
The same holds true for business. Heading off before you know your real financial position can waste a lot of resources and put your business at risk. Like knowing your latitude and longitude, knowing your financial position is a critical step to setting your course to increase the value of your company.
You may think that your financial situation is obvious – check the bank account, the net equity and a few ratios and we’re good to go, right? Hold on skipper. Let’s look a little closer and ask questions about some key numbers. Here are a few examples:
How good are your receivables? Not just the adequacy of the bad debt reserve but what about their quality as collateral? Don’t forget the aging and cross-aging covenants on your credit line. Your 80% eligible collateral may end up being 70% or less if your aging is not in good shape. That will result in less available credit.
A similar analysis is necessary on your inventory. How much of your inventory is ineligible for collateral?
Look at your fixed assets. Are they all still useful and productive assets or are you looking at costly replacements in the near future? We tend to think of and treat depreciation as simply a tax concept but assets really do depreciate – i.e. they wear out. On the other hand, because of the way GAAP records assets at historical cost, you may have assets with underlying current values that make your balance sheet much stronger than it appears. Knowing where you stand with future capital expenditures can have a significant impact on where and how far you go with your next business initiative.
Regarding any other assets on your balance sheet, you need to know that they are really assets. Another definition of an asset is an unexpired cost. Make sure you are not stacking up expired costs on your balance sheet that really belong as expenses on your income statement. Better to find out now than when your auditors, bankers or shareholders question them at year end.
With liabilities, the common problem is not what you see, it’s what you don’t see. Understating or completely missing significant liabilities not only misstates your current position, it can distort your performance reporting as well. Do you have higher than usual gross margins on some products or services that you can’t explain? The problem may be that you haven’t recorded all the liabilities and related expenses. Knowing that all your liabilities are properly recorded can give you much greater confidence that the margins on your product and service lines are correct.
Another name for a balance sheet is “the statement of financial position.” Just like in sailing, once you know your position, the decision on which direction to go can be made with confidence. As we say at B2B CFO® “First direction, then velocity.”
Whether or not your in St. Charles, Illinois, if you would like a complimentary review your financial navigation give me a call at (312)520-2599 to request a complimentary Discovery Analysis. It includes:
- A confidential meeting with the business owner(s), then staff interviews
- Look at the company’s financial information and computer systems.
- Benchmark financial information against industry averages.
- Create a confidential report of our findings in The Strategy Gameplan™