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E-Myth – “Why most small businesses don’t work & what to do about it”

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Virtual CFO | Helping Entrepreneurs Read Balance Sheets

One of the reasons why itís extremely important for entrepreneurs to learn how to read their balance sheets says virtual CFO is because itís going to allow them to make informed financial decisions in their business. There is often times that entrepreneurs are going to need to make financial decisions, and if they make those decisions without first consulting their financial statements, they may not make the best financial decision that they can. For example, if a business owner needs to buy an asset in their business, if they donít consult their financial statements to determine if they have the money, they may choose to make the purchase, and then end up in a cash crunch because they didnít have the money at the time. If a business owner is able to consult their financial statements and accurately read them, they may decide to hold off on that asset purchase until they can better afford it or business owner may see that they are having a hard time affording staff, so if they lay off staff member, that can help them become financially solvent sooner, so that they will be able to afford that asset purchase much faster

Business owners should be able to read and understand their balance sheets in order to help them make great decisions. Entrepreneurs often believe that they can make decisions based on their income statement says virtual CFO, but since there is a higher degree of probability that there are errors on interim financial statements, business owners should look at their balance sheet first because itís much more possible to detect errors on balance sheets and income statement. For example, business owners who are looking at their balance sheet may see that there credit card balance remains unchanged from one month to the next. This is the type of information thatís not available on an income statement, but business owners should understand that itís extremely rare that there credit card balance will remain identically the same from one month to the next. Virtuals CFO says that this should trigger the business owner to look for errors. The most likely error that has occurred is that a credit card charge has not been added to the balance sheet. A business owner can quickly verify if thatís been done, and fix their error. This is not something that will be noticeable on an income statement.

Another example of an error that is obvious on the balance sheet says virtual CFO is if they have noticed that there loan balance does not decrease from one month to the next. Since business owner should always be making those loan payments, if a notice that it does not decrease over a certain period of time, thereís only two possibilities that could happen: the business owner didnít make the loan payments, or that the business loan amount was entered into the balance sheet incorrectly, which could be triggering other errors. For example in profit and loss, if the loan balance was accidentally added into that category it shows that a business owner made less money than they actually did. Itís extremely important that in order to catch these errors not only do business owners need to be reviewing their balance sheets, but the balance sheet needs to be six month comparative statement as well.

A great quote from Albert Einstein says if you canít explain it simply, you donít understand it, virtuals CFO says that this is true with balance sheets. If business owners arenít able to understand or read their balance sheets in their business, they may not be able to make great financial decisions in their business. Since 50% of all entrepreneurs close their business within five years, 29% of those entrepreneurs go on to say that the reason why their business failed was because they ran out of money. Helping business owners make good financial decisions in their business can help them avoid this reason for business failure.

Itís extremely important that business owners understand that there is a potential for mistakes to be made on interim financial statements, and because of that, itís important that business owners review their balance sheets first because errors are far more noticeable on balance sheets and income statements. Virtual CFO says that by looking at a six month comparative balance sheet statement can help business owners review their finances and be able to easily see trends and anomalies. Any time a business owner sees something unusual in one month but not in the next, they should know that thatís a good reason for them to investigate further. Six month comparative balance sheet statement is an extremely powerful tool for businesses to see variances.

Business owners should also understand when there reviewing their balance sheet that when looking at their interim corporate tax accounts, it is going to be negative. Rather than this being an error, business owners should understand that corporate taxes look much differently in interim financial statements than they do in the year end statements. The reason for this, is when the business owner is making tax payment instalments, thatís not going to actually show up as a tax expense on the balance sheet until month 12. Since it doesnít show on the balance sheet, but a business owner is currently making payments each month, when a liability is prepaid, it ends up looking like a negative number on the balance sheet that gets larger each month says virtual CFO. However, when the tax bill is applied, it goes towards that negative amount in the zeros it out. If business owners donít understand that, they may see the growing negative tax balance in their business finances is something to be concerned about.

Virtual CFO says that business owners also need to look very carefully at the individual transactions in their shareholder loan account. The reason for this, is because every dollar that a business owner takes out of their shareholder loan accounts that they used personally is taxed at a 48% tax rates. If thereís any amount that has been attributed to the shareholders loan account that actually should have been attributed to business, business owners should be very mindful of in order to avoid paying personal taxes on business expenses in order to ensure that a business owner doesnít spend additional time year end trying to remember all of these instances throughout the year, if the business owner stays on top of it every month, it can be easy to account for.