It’s a leading question, I know. You may be, and you probably have good reason to feel that way. After all, at this time of year:
· You have reviewed your previous year end internal financial statements and compared them to the industry averages available from your trade association and you look “ok”. Maybe not stellar, but not bad in comparison to your peers either. In this economy, these achievements are not to be taken lightly.
· Your accountant or CPA has your results, has looked at them for reasonableness based on the prior year, asked you a few questions about them, and has proposed or already made the proper book-to-tax basis adjustments to get them (and you) into the best tax position possible.
· Your bank has been apprised of the results and they pass muster with them, they probably are comfortable because:
o Your “free cash flow” (net income with depreciation, amortization and other non-cash expenses added back), as stated has sufficiently “covered” your debt service obligations.
o Your net income for the year, less distributions for income taxes positions the company with a net worth that complies with your loan covenants.
Now for the $64,000 question:
What about the assets on your balance sheet? Financial performance is not only about the income statement. You haven’t considered them? You are NOT alone! Everybody falls in love with the number at the bottom of the income statement…the one with the double line underneath it. It is, after all, probably the most intuitively understood number for any CEO, owner or manager. However, it is only one indicator of financial performance and can be misleading if your balance sheet does not accurately portray the financial position of your company.
I know what you are thinking: Why would my balance sheet make my income statement misleading?
I know I shouldn’t do this, but I am going to answer your question with another question: How sure are you that your balance sheet accurately reflects the realizable, actual value of your assets like cash, accounts receivable and inventory?
o Are your internal controls sufficient to maintain the integrity of the amount shown on the balance sheet and protect the most vital asset your business can hold?
o Are you in the practice of printing accounts payable checks and holding them until they will clear your bank?
o Has the balance been reconciled back to the bank balance and been reviewed, questioned and signed off on by an appropriate member of management?
· Accounts receivable:
o Is it possible that invoices to your customers do not accurately summarize what was sold to your customers?
o Is it routine practice to issue material credit memos to your customers on subsequent business days after the sale?
o Are you in the practice of actively and routinely assessing the credit worthiness of your customers? If your business consists of high transactional volumes, are you actively managing your customer’s credit limits and days outstanding according to your stated terms of sale?
o How robust is your perpetual inventory system? Can it provide you with “aging” data on the purchase dates of on-hand quantities?
o Do you have routine cycle counting programs set up to verify the perpetual system quantities against physical counts?
o Do you actively manage all inventory categories for the number of days’ sales on hand or annual “turnover”?
§ If these numbers trend significantly worse than your industry averages, you run the risk of having un-saleable inventory.
If your answers to the above lead you to believe that your balance sheet accurately reflects the underlying realizable value of these assets, then you are to be applauded. Your income statement is not misleading you. You can rest easy.
If, however, your answers to the above lead you to the conclusions that your cash could be overstated; portions of your accounts receivable may be uncollectible; or your inventory might be over-valued, your income statement as currently presented is misleading you! The current year activity causing some or all of the overstatement must be appropriately written down in the form of additional expense recognized on your income statement!
In short, the assets on your balance sheet (and the supporting operations behind them) need as much pro-active, professional analysis and management as your income statement. It takes a seasoned, trusted, long term business advisor to effectively help you manage the above business risks. You can now afford one with B2B CFO®. Each B2B CFO® Partner has the experience, expertise and passion to help you with these challenges. As a firm with well over 4,000 years of collective CFO experience, each Partner can bring this collective experience to bear on behalf of each and every client. We are here to help as much as you would like.