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

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Virtual CFO | Understanding Your Balance Sheet

If entrepreneurs are making critical decisions about their business based on their income statement, they may be doing themselves a disservice says virtual CFO, because the most important information is on their balance sheet. 50% of all entrepreneurs close their business within five years, and 29% of those failed entrepreneurs will say that the reason that their business failed was because they ran out of money. Business owners should get into the habit of reviewing their balance sheet first before they look at their income statement, because itís much easier to catch errors when looking at the balance sheet first. Business owners are making extremely important business decisions, they should ensure that they are mitigating their errors before making those decisions.

Virtual CFO says that there is a high degree of probability that there are errors on the businesses income statement. If they are able to review their balance sheet first, they will be able to see those errors much more clearly. When making important financial decisions in their business such as hiring new staff, laying off staff or even purchasing assets, entrepreneurs should ensure that what they are looking at has been verified for correctness and errors caught. Rather than looking at the income statement, business owners should get into the habit of looking at their balance sheet first, and then reviewing their profit and loss statements.

Another great tool that business owners can use in order to verify the correctness of their reports, is looking at a six month comparative statements. The reason why this is important says virtuals CFO, is because it will allow the business owner to see trends that are happening in the business, or any errors or anomalies. Itís harder to take a look at one month at a time, and understand if things donít make sense. Looking at six months at a time business owner can see variances month-to-month and verify the correctness, or locate the air.

Business owners can also catch errors by looking at their balance sheet first for example if they notice that their credit card balance has been unchanged for more than another month says virtual CFO. While it may be technically possible for a credit card balance to remain unchanged for more than one month, however it should get the business owner a clue that something might not be right on their balance sheet says virtuals CFO. Chances are, that the credit card charges havenít yet been added to the balance sheet, which makes it look like that balance has been unchanged. By being aware of what errors can look like on a balance sheet, can help entrepreneurs catch those errors a lot quicker.

When entrepreneurs can understand their balance sheet, there able to make better financial decisions because they are catching errors sooner, and have a deeper understanding of whatís going on in their business. Looking at their balance sheet first, business owners can verify the correctness of their statements, which can help them in the long run when it comes to the business finances.

Business owners are often expected to make it extremely important and big business decisions, based on the important information in their financial reports says virtual CFO. However, if business owners donít understand their balance sheet, or donít know how to catch mistakes, they may be making huge financial decisions based on misinformation which can be extremely detrimental to their business. Since 50% of all businesses close their business within five years, and 29% of those entrepreneurs say that running out of cash was the reason why their business failed, business owners need to be able to make informed financial decisions in order to help them avoid running out of money.

Itís extremely important that entrepreneurs understand their balance sheets, and look at their balance sheet first before looking at other financial report says virtuals CFO. The reason is because once business owners know what theyíre looking for, they can easily detect errors, and fix those mistakes before they go on to make big financial decisions based on the financial reports they see. One example of why this is important, is if business owners can understand why the cash looks different on their balance sheet then in their bank statement. Virtual CFO says that amounts on a business ownerís balance sheet may change depending on uncleared items such as checks for example. The balance sheet will show an entrepreneur that the check has left the business, but it might not show up on the businesses bank statement until actually physically clears the bank. If the business owner is looking only at their bank balance than they may believe that they have more money than they actually do. If a business owner is looking at bank balances to determine if they have enough money for payroll, if they donít look on their balance sheets, they may cause payroll to bounce and not verifying the actually have the money in their business to use.

Another way that business owners can verify whether their balance sheet is correct, is if they notice what happens to their loan balances over time. Virtual CFO says that business owners loan balance should decrease on the balance sheet every month. If a business owner notices that this is not the case it could mean a couple of different things. The first reason why it might not show is decreasing in a certain month is because the business owner simply didnít make the loan payment. This is an extremely important mistake to fix and fix quickly. The next thing that loan balance that doesnít decrease on the balance sheet each month could mean that the loan balance amount has been attributed to another account, which may be triggering other errors throughout the financial statements. For example, if it is sitting in a profit and loss account, it can end up showing the business owner that they made far less money than they actually did.

Itís extremely important for business owners to understand their financial statements, and start with reviewing their balance sheet before moving on to their income statement in order to help them make the best financial decisions they can for their business.