Profit has grown for the last three quarters…
Revenue is up year-on-year…
Overall profit margins have increased for the fourth month running…
The statements above point to the logical conclusion that a business is in good stead financially. Profit and loss, profit margins and revenue, are all regarded as vital signs when it comes to the health of your business (and they have been since the very first business set up shop). But, before you pop the champagne corks and raise a toast, we want you to know something…
Your income statement is important. Increases in revenue, profit and profit margins are important. But, not as important as your balance sheet.
Why? The reasons are far-reaching and wide-ranging. Let’s dig into them.
Profit and loss don’t reveal what’s needed to turn a profit.
So, you turned a profit for the third year running – up by 10%, by all accounts. But why? Is this jump reflected with a rise in investment? Only your balance sheet will have the answer.
Cash is King. Which makes your profit and loss next in line to the throne.
Liquidity. It’s a key word when gauging the health of your business (and your ability to turn on a dime, should a sudden opportunity arise or disaster strike).
Liquid means cash. It’s the opposite of fixed and other assets.
You need cash for mission-critical things like meeting your payroll obligations, paying for key operational costs, and servicing your taxes. No employee, service provider or tax man is going to accept stock in their place.
Once again, only your balance sheet will illustrate this element of your business’ health.
Your balance sheet provides insight into key trends.
When you have both your income statement and balance sheet side-by-side, you have everything needed to analyse key trends helping or harming your business.
Like whether accounts receivable have shortened. Or your inventory turnover has slowed. Just two examples of trends that you should keep a beady eye on week-by-week, month-by-month.
How much do you own (and owe)?
Mortgages. You may live in a four-bed, £350,000 house, but unless you’re some way down the line to repaying it, all this means that you’re hugely indebted, rather than being the proud owner of a high-value asset.
Consider your business in the same vein.
Only your balance sheet will shed light on how much of your assets you own, and how much you owe. This is known in our industry as leverage.
If you were to apply for a business loan, the banker you sit in front of would look for four core things…
- Trends and patterns in profitability
- Trends in liquidity
- Activity (AR and inventory)
Guess what? Your profit and loss statement contains just one of these elements – the other three are sat over on your balance sheet.
So, while profit, loss, profit margins and revenue are undoubtedly important to your business, it’s the figures on the balance sheet that tell the whole story.