Rich Business, Poor Business Part II

As noted in my previous post, the balance sheet can be a management tool, not just a snapshot of your net worth. Not only should you look at your business balance sheet today, but you should forecast what you want it to look like one month from now and take active steps toward achieving those goals.

To do that, let’s start by looking at the asset side of the balance sheet. Assets can be broken down into the following components:

Current Assets

Current Assets are considered assets that have a tangible value and can be converted into cash fairly easily. They are used to measure the “liquidity” of a business, in most cases by comparing them to current liabilities (debt obligations within a fiscal year). Current assets include:

• Cash in Banks
• Inventory
• Accounts Receivables
• Stocks/Bonds/Securities

Fixed Assets (Long Term Assets)

Fixed assets have a tangible value and are generally considered assets that will not be converted into cash in the next fiscal year. Some examples of fixed assets include:

• Real Estate
• Building Improvements/Leasehold Improvements
• Operating Equipment
• Furniture and Fixtures
• Vehicles (sometimes this is considered a current asset)

Intangible Assets

Intangible assets have value, but cannot be touched. Some examples of intangible assets include:

• Trademarks/Copyrights/Patents
• Goodwill (Usually value derived from profitable operations, but can also be assigned for customer lists or market research data regardless of profitability of operations)
• Franchise Rights/Non-Compete Agreements/Sales Contracts/Letters of Intent

“Rich” business owners will pay attention to all asset lines on their balance sheets and ask two key questions:

1.Is this asset producing income?

2.Is this asset appreciating value?

If the answer is “no” to both of those questions, then the successful business owner will look to convert that asset into another type of asset that will produce a positive and measured result.

In looking at current assets, successful business owners recognize that the only truly liquid asset is their cash. So they continually strive to maintain a good handle on accounts receivable by collecting monies owed diligently and keeping their receivables to an absolute minimum. The same goes for inventory. The less inventory on hand, the more liquid their current assets remain.

Of course, some businesses will require having inventory and accounts receivable. The key is to ensure that they are at acceptable levels in relation to the business. Each industry varies with regards to acceptable levels and it is worth it to study comparative ratios. Excuse the self-gratuitous plug, but your local SBDC can be a great resource in helping with this type of analysis!

Still, the key to managing inventories and accounts receivable is the same. Pay attention to age and value. With regards to accounts receivables, forecast whether a 90-day invoice will be converted into a deposit next month or whether it is more likely to become a bad debt or require that it be written off. Also consider charging finance fees, so you are at least generating some income on that asset.

With inventory, think about how often it turns. Unless you hold an inventory that appreciates in value, you may benefit yourself by selling it at cost or below cost and using the proceeds for items that will turnover quicker. I know a lot of retailers who have this huge aversion to discounting, but inventory that doesn’t move is costing your business money instead of fulfilling the purpose of generating income.

What you do with cash in the banks, stocks, bonds and other securities depends on the advice of your wealth management advisor, so I defer to their expertise. Still, think about maximizing appreciation, income and liquidity!

As with your current assets, your fixed assets still relate to an analysis of whether they are generating income or appreciating in value. The main difference is that is much more difficult to convert a fixed asset into cash, so your return on investment analysis needs to take that into account. If you have fixed assets that are not performing and generating enough income, you may be faced with the difficult decision of either developing alternative uses for those assets or, in some cases, doing an analysis of whether you should cut your losses by not operating that asset, rather than operating at limited capacity. The key is to forecast the results and do a cost/benefit analysis.

In my opinion, intangible assets are the most difficult asset to deal with. That is because their value is, well…intangible. It is a perceived value. Gaining a return on investment, on goodwill and intellectual property is complicated because it is so difficult to assess value to creative thinking, sweat equity, and/or the past buying habits of customers in a fickle marketplace. I will say, however, that there are some successful business people who have benefited from selling intangible assets that exponentially appreciated in value, but unfortunately, there are probably just as many less successful business owners who paid the price for overvaluing the market potential of intangible assets. The dot.com boom and bust is a perfect example of this.

My hope is that I am not boring readers with these posts on accounting principles, as I still have to get into the liability side of a balance sheet in a future post.

As David Letterman once said, “There is no business like show business, but there are several businesses that are like accounting.” I dare to say all businesses relate to accounting, as you have to know how to keep score if you are going to play the game.