An explanation of the balance sheet for business owners [Part 3/4]

October 19, 2020

An explanation of the balance sheet for business owners [Part 3/4]

A balance sheet is a document that outlines the business’s value. It does this by listing three main things: the assets that a business owns, the liabilities that a business owes, and the equity, which is the assets less liabilities.

The balance sheet forms part of the management report pack that Creative CFO produces. Often, the balance sheet can be quite challenging to understand, so we have made it our mission to make it visually understandable.

 

What is the purpose of a balance sheet?

The purpose of a balance sheet is to give interested parties an idea of the company's financial position, in addition to displaying what the company owns and owes. It is important that all investors know how to use, analyze and read a balance sheet. A balance sheet may give insight or reason to invest in the business.

 

Components of the balance sheet

The balance sheet consists of three main components:

  1. Assets - what the business owns
  2. Liabilities - what the business owes
  3. Equity - this is assets less liabilities and represents the accounting business value.

    What does a healthy balance sheet look like?

    Every business owner wants to know that their balance sheet is looking good. But what exactly does this mean? We have recorded a short video to explain.  

     

    What steps can be taken to improve the balance sheet?

    When a business’s balance sheet is not looking too healthy, the business owners might consider taking some steps. The balance sheet can be improved in a couple of ways. Some steps can be taken immediately, but mostly the business owners have to put longer-term strategies in place to ensure positive change in the business’s financial position.

    If the strategy of the business is to improve equity and make the business more attractive for potential investors, the following steps can be taken:

    Immediate actions

    1. Pay close attention to inventory control
    2. Improve debt collection days
    3. Review all business expenses and ensure that the cost are needed to increase profitability
    4. Review procurement strategy and negotiate with suppliers for better rates
    5. Look for “low hanging fruit” opportunities in terms of sales.
      Longer-term actions
      1. Put a strategy in place to see how debt can be paid off faster
      2. Review underperforming assets and consider selling if necessary
      3. Ensure the business stays cash positive and saves for a rainy day.

            When is a business insolvent and what does it mean for directors?

            One important use for a balance sheet is to show whether or not a business is insolvent.

            A business is insolvent when its total liabilities exceed its total assets. In other words, the business owes more than it owns. This shows that a company is in financial distress.

            The Companies Act 71 of 2008 defines “financially in distress” in section 128 (f) as:

            1. reasonably unlikely that the company will be able to pay all of its debts as they fall due and payable within the immediately ensuing six months, or 
            2. reasonably likely that the company will become insolvent within the immediately ensuing six months. 

            There are two types of insolvency:

            1. Technically insolvent: Liabilities are more than assets (fairly valued)
            2. Commercially insolvent: A business is unable to pay its debts even though the assets may exceed liabilities.

            It is the directors’ responsibility to assess insolvency and to ensure that the business will be able to continue as a going concern in the foreseeable future. Should there be warning signs of the business not being able to continue as a going concern directors need to take immediate action by seeking legal and financial advice. Should a director not take the necessary steps, they may be held responsible for losses incurred.

             

            When is the best time to get a balance sheet?

            Now is the best time to get a balance sheet, but more importantly any business should monitor their balance sheet on a regular basis and the goal should be to improve the balance sheet. Creative CFO is well equipped to prepare a balance sheet for your business.

            Speak to our  helpful consultants they are available for your reporting and business processing needs.

            👉   READ: Part 4 - Understanding and achieving a healthy cash flow


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