By Doug Bertinshaw
Over the last 24.43 years, I have noticed that while most Business-Owners read and understand their Profit and Loss Account, the Balance Sheet always seems to take second place. It has been referred to as the “BS” report. I needn’t tell you what the B and the S stand for. In actuality, the Balance Sheet says so much more about a business than the Profit and Loss Statement.
Simply put, the Balance Sheet contains details of what the business owns (the Assets) and what the business owes (the Liabilities). The difference between these two numbers is the Net Assets or the Equity of the business, a.k.a. the earnings that have been retained in the business (Retained Earnings). Note that this is NOT the market value of the business (an entirely separate topic).
By retaining some profits, you will ensure that your business has a buffer for a rainy day. A solid rule of thumb is to make sure you have two month’s overhead easily accessible.
Downturns happen. They can be major and unexpected, like an economic crisis or relatively minor like seasonal lulls. How a business survives any downturn is to a very large extent determined by what reserves it carries. A large amount of Retained Earnings will provide a buffer for the business to survive inevitable downturns that happen. A business that has little or no Retained Earnings experiences a dramatic reduction in turnover, it may have to rely on the Principals’ own sources of funds to get it through that tough spot.
Grab your recent Balance Sheet and have a look. Chances are pretty good that this Balance Sheet will have a comparative column to the right of it with the numbers for the year prior. What has happened to your Retained Earnings over these two years? You can pretty easily calculate your critical KPIs relating to liquidity and solvency.
It takes just a little effort to increase your financial literacy and thus, your potential for success. Your business’ Retained Earnings are critical to the long-term success of your business. Nurture them.
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