Does your balance sheet really convey your small businesses true value?
As I discussed in a blog post last month, financial statements for both small and large businesses include something that is called a balance sheet. And a balance sheet is an accounting report that displays a company’s assets and liabilities and will show a snapshot of the business’s financial standings for a particular point in time. The question is how useful is a balance sheet for a small business owner? If your business has investors or you want to get a loan or line of credit, it can give people are glimpse idea of what your company might be worth or valued at.
Here is the thing especially for a small business, a balance sheet does not give a full view of the financial health of the business. Because it just shows a specific period or snapshot of a point in time. And things can change rather quickly. Publicly traded corporations usually file their quarterly financial statements with the SEC, around 45 days after the quarter ends, which can seem like a long period of time investors and traders. And this for public companies that use enterprise level software and financial reporting systems that will be far more robust than what a startup or small business would use.
And many small businesses do not even prepare financial statements every quarter, some may only do it once a year to prepare for tax filing season. Some companies may use Quickbooks or other accounting software to generate financial information, but generally, it will not be as accurate until their CPA does or reviews and makes adjustments. And then what often can happen is that by the time the accounting professional cleans up the balance sheet or other financial statements, the information might not be an accurate representation of the companies finances.
Balance Sheet data does not tell the full financial story
Sometimes the data for listing the value of the assets and liabilities can be misleading. Why? Because of generally accepted accounting principles (GAAP) demand that assets and liabilities are listed on the balance sheet at “cost” or what is known as “book value.” And for types of assets such as cash or current accounts receivable, and accounts payable that is fine. But if ask an investor and analyst that is looking to put a value on a company, some will say that there are certain items on a business’s balance sheet that need to be changed to show a better market value representation:
- So say you purchased a computer for $1,000 last year, or you bought $20,000 worth of manufacturing equipment 8 years ago. If you had to resell them what would they be worth today? Meaning what would the market be willing to pay for them?
- Another example could be a company owes a vendor or financial institution $200,000 that is payable over the next 3 years. What would be the true value of that liability in real dollars based on today and future interest rates?
- Thirdly, let’s talk about intangible assets such as trademarks, patents, licensing agreements, data? Most of these assets are listed and carrier at cost on a balance sheet, which might be undervaluing them compared to what they might be worth to a potential investor or Acquirer.
So if you are looking to position your business to get purchased or acquired, we often would recommend that a full revaluation of your balance sheet be undertaken to get a better reflection of the current market value of your assets and liabilities. And if your company is not doing this a regular basis, then your balance sheet could be giving your startup or small business a not so accurate representation of its true value or worth.
Balance sheets also leave a lot of things out. Investors and stock analysts will often say that they go to the footnotes when a company releases their financial statements. Why? That is because the footnotes report the details and additional information that are left out of the main parts of reporting documents in companies financial statements such as the balance sheet. This is where you can find out much more about the liabilities, commitments, leases, even potential or pending lawsuits — that may have not been reflected. Or you can find out info such as even though the accounts receivable looks solid at first glance, it is made of only a few large customers, where if any one of them did not pay it could cause a significant disruption to the cash flow of the business.
The footnotes will be used to explain how a particular value was assessed on a specific line item. This can include issues such as depreciation or any incident where an estimate of future financial outcomes had to be determined.
In the footnotes, you can also learn how the inventory and assets are actually valued, (FIFO and LIFO are cost layering methods used to value the cost of goods sold and ending inventory) and does the methodology makes sense in the real world of buying and selling.
And what if you are looking for the true value of important things such as retail store’s location, or potential new sales contract that is coming down the pipeline, or a recent rockstar engineer employee hire. None of this type of information is listed on the balance sheet. One other thing that is also not reflected on the balance sheet, which is important for investors; goodwill or brand value. According to an article in The Street by Ellen Chang, “a company’s goodwill represents its brand reputation, loyalty, along with patents or proprietary technology and adds significant value.”
Meaning goodwill is the residual amount of what a company is worth and the value that an investor will pay for it over the net worth of the company. So of course, a balance sheet does show some useful information about your business.
If you want to manage the financial metrics of your business, it might be more useful to look at things such as margins, sales, payroll and product profits, these will give you a clearer view of how your small business is doing. Thomas Huckabee CPA offers a wide range of tax, accounting and outsourced CFO consulting services, feel free to contact with any questions with a free consultation.