Among all the tools entrepreneurs have to monitor what's going on in their businesses, one of the most important--and least used--is the balance sheet. Most people understand the concept of an income statement, even if they don't really know how to use one. They're aware that you won't last long in business if you're not consistently earning a profit on whatever it is you sell. A balance sheet, on the other hand, can be confusing, and many don't understand what it's for. That can be a problem.
I'll give you the example of Claire Theobald, whom I've been working with since last June. Claire's company, Beatrix New York, makes colorful children's backpacks, lunchboxes, water bottles, and similar products in China and sells them in several countries, but mainly the United States. When she first came to see me, she was struggling with cash flow and didn't understand why. Like many of the young entrepreneurs I advise, she had no idea how to use her financials to track what was really going on with her business.
I showed her how to create a monthly income statement, which neither her accountant nor anyone else had ever helped her with. I also had her do monthly income statements for the previous two years so we could see any trends. That's when she mentioned that, despite repeated requests, her China warehouse, near where she does her manufacturing, hadn't sent her a bill in 18 months. Her income statements would be inaccurate without it.
She finally got the bill, and it was a shocker. Unlike her California warehouse, which charged a fixed monthly fee, the China warehouse charged by amount of space used. The bill was huge.
"We need to look at your balance sheet," I said.
"Why?" she asked.
"Because something's happening with your inventory, which is on the balance sheet," I said. It was immediately apparent that Claire's inventory was high, given her sales, and taking up a lot of space in her China warehouse.
"That's because of the suitcases," she said. She explained that she had added children's suitcases to her product line but they hadn't sold well. She was selling them and other products at a 20 percent discount on her website.
We calculated what she spent on storing the suitcases and then shipping them, and the cost was more than they were worth. I suggested she give away the ones in the China warehouse to the workers there. (She did, and they were thrilled.) I also suggested she discount the items on her website, mostly sold in the U.S., by 50 percent. The faster she got rid of them, the more time she would have for other, more productive activities, especially sales. And by doing both, she would simultaneously reduce her costs and generate additional cash.
But mainly, I wanted her to understand why she needed to keep an eye on the balance sheet as well as the income statement. By definition, a company is insolvent when its short-term liabilities exceed its short-term assets. Those assets include inventory and receivables. If you have a lot of old receivables that can't be collected, or a lot of old inventory that can't be sold, you could become insolvent, even if you appear to be profitable on your income statement, and insolvency is one step away from bankruptcy.
And she got it. Claire always had a gift for imagining and designing successful products. She was good enough at sales and getting her products made and distributed. Now, she also has an excellent understanding of the numbers. In my book, that makes her a real businessperson, which I mean as high praise.