Virtual CFO | Why Is Reading Balance Sheets Important
One of the biggest reasons why itís extremely important that entrepreneurs learn how to read balance sheets in their business says virtual CFO, is so that they can make informed financial decisions in their business. If an entrepreneur makes financial decisions in their business without clearly understanding what the finances in their business are currently doing, they risk making a poor financial decision. Since 50% of all entrepreneurs close their business within five years, 29% of those entrepreneurs will go on to say that they failed in business because they ran out of money. Helping business owners make better financial decisions can help them overcome this problem.
Business owners should understand that when they are reviewing their financial statements, they should start with their balance sheet, and that they should be looking at their balance sheet as it six month comparative statement. The reason for this says virtuals CFO, is because there is a higher chance that there are errors on interim statements. Itís much easier to catch errors when looking at balance sheets then it is looking at income statements or profit and loss statements.
One of the first things that business owners should understand when there reviewing their balance statements, is that their cash is going to look differently they are then it will in their bank account. The reason for this says virtual CFO is because amounts that appear on the balance sheet have already been subjected to uncleared items. For example, checks that need to be cashed are going to appear on the balance sheet where they wonít appear on their bank statement. This can create problems for business owners if there only looking at their bank statement, because it may show that they have more money in their bank account then they actually do. If a business owner decides to spend money, when theyíre waiting for payroll to clear, they can cause their payroll to bounce which could be extremely devastating to the business. Other reasons why their balance sheet may look different in their bank statement is waiting for their own deposits to clear, or if they have bank machines, these may take a day or two to show up in their bank account, but will show up immediately on the business owners balance sheet.
Entrepreneurs should also understand that when they are adding long-term assets to their balance sheets, they should go under property, plant and equipment. Virtuals CFO says when business owners are adding assets to this section, they should ensure that the asset has a value thatís greater than $1000, and have a useful life longer than one year. Thereís no point in counting assets that have a lower financial value than not even if they technically count as an asset.
When business owners understand how to read their balance sheets, and check for errors virtual CFO says that they are better equipped to make financial decisions in their business that can help them grow their business and help them avoid running out of money in their business which is what causes 29% of failed businesses to close the door.
More often than not, entrepreneurs need to make critical financial decisions in their business before they have their year-end financial statements prepared by their accountant says virtual CFO. Because of this, itís extremely important that entrepreneurs learn how to read their own financial documents, in order to make informed decisions about their finances. Business owners should understand that the most important information is on their balance sheets, and they should start with reading and understanding their balance sheet.
Since interim financial statements are prepared by an accountant, business owners should understand that they have a higher degree of likelihood that there are errors on the statements. Because of that, itís critical that a business owner reviews their balance sheets first, because the errors that appear on those statements are much more obvious than errors on income statements or profit and loss statements. Virtuals CFO says that being able to look at six month comparative balance sheet will allow business owners to see if there are any variances over a six-month period that donít make sense. A six month comparative statement is a powerful tool for business owners to use to look for errors.
Another easy way to check for errors on balance sheets is to look at the credit card balances says virtual CFO. If the credit card charges have not changed from one month to the next then business owners should be reasonably certain that the reason for that is because they havenít yet been added to the balance sheet. If a business owner is only looking on their income statement, they are going to miss this error. Once a business owner has discovered this mistake, they should check to make sure other balances have been added correctly. This one error in the statement can trigger other errors elsewhere, so itís a good indicator for business owners to pay attention to.
The second way that business owners can easily check their balance sheet for errors, is looking at their loan balances. Virtual CFO says that business owners should see that there loan balances are decreasing each month as they pay off their loan. If however an entrepreneur notices that this is not the case, this can mean one of two circumstances, the business owner either did not make that loan payment, or the amount was entered into the balance sheet incorrectly and is potentially sitting in another account which is causing more errors throughout the rest of the balance sheet.
If entrepreneurs can investigate that and figure out where the air is, they can ensure their catching errors on their balance sheets, and if they catch no errors, they will be able to make their financial decisions based on the information given to them in their balance sheets. Making informed decisions in their business can help business owners grow their business and avoid running into potential cash problems.