Seeds to Success: Cultivating a Healthy Balance Sheet for Your Business

My husband and I have sort of started a small side hustle selling vegetables to our neighbors. We know how to grow beautiful and tasty vegetables and excel at presenting our veggie boxes. However, we struggle to organize our expenses and track costs, income, and net profit.

I think the biggest hurdle to starting your business, from our experience, is setting up and understanding all the financial statements and the mechanics of a "healthy-looking business." For my husband and I, it's just a matter of sitting down and doing it! It takes patience and collaboration with your business partner, and then there is the added element of we just want to do the part that we love, which is to grow the food and sell locally. We aren’t as enthusiastic about tracking cash inflow and outflow, deciding how much debt to take on, how much we should invest into the venture, how much do we need to earn to break even, etc. However, we understand we need to know all these details because, at the end of the day, you start a business to make money, and if you spend time on the financials, it will be much easier to make it successful.

So, how does one ensure their business is "healthy?" While the health of a business can be subjective to the industry, I find there is a lot to learn from a company's balance sheet.

A healthy balance sheet is a cornerstone of any successful small business.

The balance sheet is a snapshot of a company's financial health, showing what it owns (assets), what it owes (liabilities), and the owner's stake in the business (equity).

Assets: These are resources owned by the company that have economic value and are expected to provide future benefits. Assets are typically categorized as current assets (which can be converted into cash within one year, such as cash, accounts receivable, and inventory) and non-current assets (long-term investments, property, plant and equipment, and intangible assets).

Liabilities: These are obligations that the company owes to others, such as loans, accounts payable, and mortgages. Liabilities are also divided into current liabilities (due within one year) and non-current liabilities (due after one year).

Equity: Also known as shareholders’ equity or owners’ equity, this represents the residual interest in the assets of the company after deducting liabilities. Equity includes common stock, retained earnings, and additional paid-in capital.

The balance sheet is based on the accounting equation:

Assets = Liabilities + Equity

Why the Balance Sheet Matters

Financial Health: The balance sheet clearly shows a company's financial health, showing what it owns and owes. This is crucial for understanding the company's stability, liquidity, and solvency. The balance sheet helps one identify potential risks, such as high levels of debt or insufficient cash flow to cover liabilities, which can impact the company's future operations and success, especially during poor markets.

Decision Making: Investors, creditors, and management use the balance sheet to make informed decisions. For example, investors evaluate a company's balance sheet to decide whether to buy or sell its stock. At the same time, creditors might assess the company's ability to repay debt. If a part of your business model is borrowing, having good credit is essential.

Performance Tracking: By comparing balance sheets over time, one can track the company's financial performance and growth. Assets, liabilities, and equity changes can indicate how well the company manages its resources.

Increased assets, such as cash, accounts receivable, or inventory, can indicate solid sales and revenue generation. Conversely, a decrease in assets or an increase in slow-moving inventory might suggest declining sales or inefficient inventory management.

A decrease in liabilities, such as a reduction in short-term debt or accounts payable, can suggest that the company effectively manages its debt and pays off its obligations.

An increase in liabilities might indicate that the company is taking on more debt to finance its operations or investments, which could be a concern if it becomes unsustainable.

An increase in equity, such as through retained earnings or additional shareholder investments, can indicate that the company is profitable and generating value for its owners. A decrease in equity might be a red flag, suggesting that the company is experiencing losses or distributing too much to shareholders in dividends.

Characteristics of a Healthy Balance Sheet

Positive Net Worth: Your assets exceed liabilities, indicating financial stability.
Liquidity: Having enough current assets, such as cash and accounts receivable, to cover current liabilities ensures you can meet short-term obligations.
Manageable Debt: A reasonable amount of debt relative to equity (debt-to-equity ratio) suggests a sustainable level of borrowing.
Asset Efficiency: Assets should generate revenue and contribute to the growth of the business.

Steps to Achieve a Healthy Balance Sheet

Increase Assets
• Focus on growing your revenue and profits.
• Invest in assets that contribute to business growth, such as equipment or inventory.
Reduce Liabilities
• Prioritize paying down high-interest or short-term debt.
• Negotiate better terms with suppliers or creditors to extend payment periods.
Improve Cash Flow
• Accelerate the collection of accounts receivable.
• Manage inventory levels to avoid tying up too much cash.
• Control expenses and find cost-saving opportunities.
Monitor Key Ratios
• Monitor financial ratios such as the current ratio (current assets/current liabilities) and debt-to-equity ratio to assess liquidity and leverage.
Regularly Review Your Balance Sheet
• Try to identify trends, potential issues, and areas for improvement.
• Compare your balance sheet over time to track progress.

Things to Watch Out For

Overreliance on Debt: Excessive borrowing can lead to financial strain and limit future growth opportunities.
Obsolete or Slow-Moving Inventory: This can tie up cash and reduce profitability.
Inaccurate Asset Valuation: Overvalued assets can give a false sense of financial health.

Conclusion

I'm sure you've heard the saying, "It takes money to make money." This is why business owners take out loans, bring on outside investors to kickstart their companies, and put all their savings into starting their businesses. You must invest in your business (both time and money) for it to grow and gain market share. So, find the tools and people to help you do this well. For example, QuickBooks is a great accounting tool that tracks your profit and loss and generates the critical financial statements any business needs – balance sheet, income statement, and cash flow. And consider consulting with an accountant or financial advisor like me to help set you up on the right path. I might not want to do it for my own farm venture, but I love helping others figure it out and gain the confidence they need to be financially successful.

~ Rachel Bubb