Focusing on your bank balances as a guide for strong business performance can be misleading.
I want you to lose the habit of getting excited when you have relatively strong bank balances.
This convenience of liquidity can force you to make irrational and poor business decisions. You have to ask yourself if this is truly a direct result of an increase in profit.
This is why it is so important to analyze your balance sheet regularly.
Did you recently get a loan? Are you paying all of your expenses with a credit card or line of credit? Are you incurring expenses with personal funds? How much do you owe in sales tax at the end of the quarter? What do your payroll liabilities look like? What is the balance sitting in Accounts Payable? Do you even pay your bills? Did you receive deposits for jobs that you haven’t even started yet?
If you answered yes to one or more of any of these questions, then it is pertinent that you take a step back.
You really need to start focusing on the equity section of your balance sheet. For starters, Assets = Liabilities + Equity. Unfortunately, Assets does not equal Profit. Your equity section will contain Net Income by default (which is your primary profit indicator) as well as other Owner/Partner Equity accounts and Retained Earnings (my favorite). We will dig into all of these fancy accounts right here by yours truly but for now I want you to start programming yourself to shift your focus from the asset section and key in on your equity section (as it pertains to analyzing profitability) instead. Of course, you still need to be concerned with cash flow so I am only speaking in terms of assessing the performance of your business.
As a result, you will become a smarter business owner. You will eventually begin to understand the true key factors that drive the profitability (or loss) of your business and take action accordingly. Doesn’t that sound much better than just getting another loan whenever you are tight on funds, just to keep the ball rolling and get your bank balance back to a decent size? There are plenty of small businesses out there that carry an average of $5,000 in their primary operating account with extremely solid financials!
I admit though – having a large bank balance is nice! However, last time I checked, I’m pretty sure interest payments (AKA throwing money out the window) and penalties for late filings (AKA throwing money out the window) are definitely not pleasant experiences. Understanding the financial health of your business will help you avoid these depressing facets of owning a company.
Think Equity, not Assets!