Understanding the balance sheet

All first year accounting students are taught a simple formula that is the basis for understanding the balance sheet: assets = liabilities + equity. We're going to break down these three elements in the most basic terms so you can understand exactly what a balance sheet is trying to communicate.

First, assets. This is what you own. Sometimes you may own it with the bank, but never-the-less you own it. Things like cash in the bank, accounts receivable, deposits with utility companies, equipment, cars, real estate, etc. Notice there's a particular order to the above list. The assets listed first are readily convertible to cash while those at the end are less so. This is also how assets are presented on the balance sheet. Those that are 'current' or easily converted to cash are listed first while those that are 'non-current' are listed toward the bottom.

Second, liabilities. These are what you owe. Accounts payable, credit card balances, the outstanding balances on lines of credit and mortgages are all examples. Again, the 'current' liabilities, those that must be paid soonest are listed first while 'long-term' liabilities such as mortgages come last.

Equity by definition is what's left over. If you do a little algebra on the above formula you can restate it as assets - liabilities = equity. Common forms of equity are capital contributed by the owners and retained earnings. This last area, retained earnings, is what ties the balance sheet and the income statement together. The very bottom number on the income statement, the net income number, flows through to the equity section of the balance sheet as retained earnings.

Now, the beauty of accounting is that this formula ALWAYS has to be in balance. So let's say I borrow $100,000 from the bank and deposit it into my business bank account. My assets go up by $100,000 because my bank account balance went up. My liabilities also go up because I now owe the bank $100,000. There is no change in equity.

As another example suppose I took $100,000 out of my personal savings and gave it to the business. Assets go up by the same $100,000 but I don't owe anyone anything. My contribution of capital is considered equity so it goes up $100,000.

Before we move on to the income statement and how it affects things lets consider a transaction that occurs completely in one category. Suppose, I sell a piece of equipment and get $5,000 cash for it. My assets increase $5,000 from the cash received but my assets also decrease by $5,000 because the equipment is no longer mine. So there's no change in total assets, no change in liabilities and no change in equity. A similar situation can occur when a loan is refinanced. You're just trading one liability for another.

As mentioned earlier, transactions on the income statement also come into play. When a customer pays you for goods or services it increases your profits, thereby increasing the retained earnings in the equity section of the balance sheet. Assets also go up because you receive cash as part of the transaction. If you offer your customers credit then it's not cash that goes up, it's your accounts receivable asset that goes up. Any transaction can be broken down this way.

I like to use an analogy when comparing the balance sheet and the income statement. Picture a runner on a track. The income statement is a reflection of how fast the runner can get around the track. But the balance sheet is like a report from the runner's doctor that tells you how healthy he is. It's possible that the runner can turn out an impressive time on the track, but drink a fifth of vodka and smoke a pack of cigarettes when no one is watching. If you can get the runner to do two laps, or three laps, of ten laps you'll probably be able to tell if he's not in the greatest shape. But if you only have time to watch one lap you may get misled. Or better yet, suppose you are trying to determine BEFORE the race starts just how many laps he's going to be able to complete. It would be nice to have the doctor's report to get some real predictive insight into how fit the runner really is.

The balance sheet provides just such a picture of a company's health. If you see a company with very few current assets (cash and receivables) but a lot of current liabilities such as accounts payable, credit card debt and short-term lines of credit you should know you've got a potential problem on your hands. If you see a company that has very little equity and a lot of assets you need to hone in on the liabilities and understand them because that's what is keeping the business running. If you look at two companies and one requires twice as many assets as another to produce the same amount of profit you might want to find out if those assets need to be replaced.

The balance sheet is the least understood financial statement, but it holds the promise of far greater understanding of your company and your ability to continue in the face of tough economic times. We've only scratched the surface. If you really want to get excited give us a call and we'll go through your balance sheet with you so you can start increasing the financial IQ of your business.

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Do that which you dread, first.

Mark Twain is attributed with the quote "If you have to eat a frog, don't look at it for too long." The idea is simple. If you want to increase your productivity, lessen stress and get more out of your day do the thing which you're absolutely dreading, first. And don't think about it, just do it!

This is great advice, and I've used it on many occasions to pick myself up out of a rut. The problem is that some times we don't realize what's got us down. As business owners and managers we often get burdened with a multitude of unsavory tasks and rather than one ugly frog sitting on the corner of the desk we feel like there's a whole room full of insects waiting to be digested. If this describes the way you're feeling this Monday morning try the following exercise.

You need an hour. If you're not committed to giving up the next hour to feel better and less stressed print this out, put it aside and come back to it when you have the time or when you have the desire to make the time. Trust me, if you just read through this email it won't be as powerful as if you follow the exercise through to the end and to do that YOU NEED AN HOUR. If you just read it through you're going to think about it too much, otherwise known as procrastination. If you aren't committed to spending the next hour on this stop reading and go do something more important.

OK, you're in...good. First clear off your desk. Don't spend more than five minutes preparing your work area. If you can't clear a spot in five minutes go to a conference room or the coffee shop downstairs. Just find a clean place to work. Take only a pad of paper and a pen with you.

During the next five minutes write down all of the stuff that you're worried about, all the things your procrastinating and all the decisions you face that are creating doubt. Go as hard as you can for five minutes and don't let up. Keep the pen moving.

Take a quick break for a minute or two. Now for another five minutes go back through the list and if you can delegate a task to someone on your team write their name in the left hand margin. The trick here is not to become a martyr by taking on too much, but also don't slough off your responsibility as the leader by delegating something that should truly be on your plate. And don't thing about it too much. Five minutes is all you need.

By now you've spent 15-20 minutes of our hour. This is where you're going to earn your pay for the day. Very quickly go back through the list and pick the TWO items you can't delegate that are causing you the most stress. This shouldn't take you more than 30 seconds. You know what's got you stressed out. Pick the two biggest culprits and ATTACK THEM RIGHT NOW. You have two twenty minutes blocks of time left. For each item decide what you can do in the next twenty minutes to make significant headway if not wipe it out entirely. Don't procrastinate any more. JUST DO IT!

When I do this exercise I find that twenty minutes is way more time than I need. Once these two "frogs" are taken care of you may decide to go on and knock out several of the other items that are causing you stress. Congratulations, you're on your way to a fantastic day!

Memory is a poor substitute for data

A good friend of mine counsels couples on how to handle their finances. His experience is that rarely, in fact almost never, do people accurately recall how much they spend on various things in the course of a month. If they think they spend $600 a week on groceries they probably spend $850. If they think $300 is an accurate figure for meals and entertainment it's probably something like $500.

Our memory will often lead us wherever we want to go. It's a willing accomplice in our self serving attempts to recast the facts more to our liking. The problem is that numbers don't lie. They can't. They might raise more questions than answers at times. But they won't mislead you. Numbers are just numbers. There is nothing either innocent or sinister about them. Facts are just facts. They reveal infomration. It's up to you to use it to your advantage.

In our quest to run our businesses better we should be on the lookout for good information at all times. Most businesses have an impression of who their customer is, but very few can back up that impression with a set of facts. We usually know how long it takes someone to reach a buying decision but very few of us have broken down the process and measured it to find out exactly where the critical decision point is made.

My point is this, you settle for anecdotes and gut feelings way more than you should. The same way you measure your finances you need to take stock of other areas of your business. Your customer service experience, your sales process, your employee development program all of these areas yield the potential for greater understanding and improvement if you'll just take the time to gather good information.

A good place to start is a process map. This is a diagram that explains how your business handles a particular scenario. For instance, in my business I have a process map that explains what happens from the time I meet someone at a networking event until the 30th day after their first invoice. This process covers networking, prospecting, selling, setting up new clients, logging in work to be done, delegating jobs to staff, reviewing the work, billing it, and following up to make sure everything is satisfactory.

Process maps take out all of the assumptions about how something is done and make you think about every step. They can be a good tool to help you start identifying where you can gather more information and where you may just be taking things for granted in your business. If you need some help putting one together give me a call. And don't forget to make it a great week!

Surround yourself with good people.

In working with business owners over the years I've learned that a lot of their success or failure has to do with the types of people they surround themselves with. This is not rocket science. A guy named Keith Ferrazzi wrote a book called "Never Eat Alone" and in it he describes the epiphany he came to as a kid while caddying at the local country club. The people who were really successful all hung out together. They did favors for each other, looked after one another's kids and traded business back and forth on a regular basis. Ferrazzi quickly learned that fun, fulfillment and accomplishment had much more to do with relationships than job titles, salary numbers or credentials.

I see business owners hanging out with the wrong people all the time. In my work with clients I get them to focus on three groups of people: employees, customers and family. Not surprisingly this is the biggest area where business owners get tripped up in their relationships.

Employees who do not share your enthusiasm, passion and drive act like an anchor that keeps your business from moving forward. As the captain of the boat you can throttle the engines all you want. You may even succeed in inching forward, but you'll never really go anywhere. Sadly, there's rarely more than one option here and most business owners avoid it like the plague. Sooner or later you're going to have to let go of that person. Of course there are times when the business owner is the anchor holding everyone else back. If this describes you we need to talk. Life is too short for you to be a drag on those around you.

Customers can also hurt your performance. I came to the realization in my first year in business that some of my customers, some of my highest PAYING customers, were killing my business. These people create headaches, they enjoy being demanding, they usually have an inferiority complex and you cringe when they call you on the phone. Again, life is too short. You need to let these people become your competitor's problem.

Last, your family can bring you down. But here's the thing, the family that is closest to you is rarely the problem. It's more often the case that you've been bringing them down for a long time and now that you want to change there's no reservoir of goodwill and they just don't believe your capable of becoming a happy, fulfilled and successful person overnight. If this describes your situation you've got a tough road ahead, but it's also the most rewarding journey you'll ever take. The process of winning over a spouse again and gaining that trust back is difficult, but if you stick it out and continue to plug away no matter what the circumstances the reward is very, very sweet. The same goes for rebuilding a relationship with your children. It takes time to earn that trust back, but with persistence it can be done.

Extended family and friends are often the most toxic area as far as relationships are concerned. When I first start working with people I find out that almost all of them have surrounded themselves with people who constantly bitch and moan, who refuse to take responsibility or be held accountable, who expect the world to cut them a deal, who give only when they know they'll get in return. I don't care if it's your brother-in-law, your best friend since grade school, or that person who "would do anything for you." You must distance yourself from these people. Until you do your life will be less than it could be. The simple fact is that these people will drag you down and you must cut them loose. Trust me, you will soon find that the world is full of people who want to surround themselves with people like you, people who want to accomplish great things and have the time of their life along the way.

Don’t take yourself too seriously.

As a business owner it's all too easy to get wrapped up in schedules and appointments and all the responsibilities that come with business ownership. It's even easier to think that success or failure depends upon our every move. WHAT A JOKE!

One thing business owners need to realize is that the way they go about things, the way they live their lives, is only one of many possible alternatives. The decision could have just as easily gone the other way. The product could have just as quickly turned out to be a failure. The location is probably one of several that could have worked. My point is this, most business owners spend so much time agonizing over details and trying to make sure every last angle is covered that they often lose perspective. Sometimes you just get lucky. Sometimes you succeed in spite of yourself. And yes, sometimes it has nothing to do with you.

The problem with taking yourself too seriously is that slowly you build yourself into a prison of your own making. People around you start to perceive you as the up tight, controlling, narcissist that has to be involved in everything. Your staff watches as you assume responsibilities that are supposed to be theirs and they smirk with satisfaction when you realize a setback. These people are no fun to be around because they operate in a world where mistakes aren't supposed to happen and people aren't supposed to act human. On the rare occasion when these types of people let their guard down others don't trust them and often use such vulnerable moments against them.

Here's a prescription for those of you who may be taking yourself too seriously. First, ask yourself what's really important. Listen to this story from a recent NPR broadcast and see if you feel like you're missing out on something. Life isn't all about work or being right all the time.

Second, laugh. Watch a good comedy, read a funny book, hang out with people who have a good sense of humor. Laughter is something no one should go a day without. Those people who radiate the most joy are those looking for an excuse to laugh. If you want to experience joy hang out with a three year old all day. They wake up in the morning and their sole purpose in life is to play and have fun. When was the last time you gave yourself a whole day to have fun?

Third, listen more than you talk AND give up being critical. Most people with this problem have a way of bursting onto the scene, issuing a flurry of instructions and disappearing back into a cloud of frantic activity. Slow down, ask good questions and take the answers with you. Avoid the temptation to solve every problem on the spot. Acknowledge a difficult problem and let someone else come up with an answer. Sooner or later you'll learn it's not all about you.