Business Navigation A Setting A Course For Your Business
Mar 16, 2009
The most fundamental rule of navigation is - "You must first know where you are before you can know which way to go.
Sometimes it may seem obvious which way to go but without knowing your real position how do you know if you are heading in the right direction? Picture yourself sailing along in the Pacific Ocean on your way to Hawaii. If you thought that you were just east of the islands it would make sense to sail west to get there. But if you had unknowingly sailed past the islands in the night, while sailing west you would have thousands of miles of open ocean before you hit land. You would be wasting a lot of time and risking your life because you simply did not really know where you were before continuing on your course.
The same holds true for business. Heading off before you know your real financial position can waste a lot of resources and put your business at risk. Like knowing your latitude and longitude, knowing your financial position is a critical step to setting your course to increase the value of your company.
You may think that your financial situation is obvious. - check the back account for the cash balance, the net equity and a few ratios and we are good to go, right? Hold on captain. Let's look a little closer and ask some questions about some of the key numbers. Here are a few examples.
How good are your receivables? Not just the adequacy of the bad debt reserve but what about the quality of the collateral? Don't forget about the aging and cross aging covenants on your credit line. Your 80% eligible collateral may end up being 70% or less if your aging is not in good shape. That will result in less available credit.
A similar analysis is necessary on your inventory. How much of your inventory is ineligible for borrowing collateral.
Look at your fixed assets. Are they all still useful and productive assets or are you looking at costly replacements in the near future. We tend to think of and treat depreciation as simply a tax concept, but assets really do depreciate - i.e. they wear out. On the other hand, because of the way that conventional accounting treats historical cost, you may have assets with underlying current values that make your balance sheet much stronger than it appears. Knowing where you stand with future capital expenditures can have a significant impact on where and how far you go with your next business initiative.
Regarding any other assets on your balance sheet, you need to know that they are really assets. Another definition of an asset is an unexpired cost. Make sure that you are not stacking up expired costs on your balance sheet that really belong as expenses on the income statement. Better to find out now rather than waiting until your auditors, bankers or shareholders ask you about them at year-end.
With liabilities, the common problem is not what you see; it is what you don't see. Understating or completely missing significant liabilities not only misstates your current position, it can also distort your performance reporting as well. Do you have higher than usual gross margins on some products or services that you can't explain? The problem may be that you have not recorded all the liabilities and related expenses. Knowing that all of your liabilities are properly recorded can give you much greater confidence that the margins on your product and service lines are correct.
Another name for a balance sheet is "the statement of financial position". Just like in sailing, once you know your position, the decision on which direction to go can be made with confidence. To put it another way - First Direction and then Velocity.
Please feel free to call me with any comments, questions or suggestions that you may have. My office number is 813-994-0416 and my cell phone number is 786-281-4527.