Navigate Business with a Good to Great Balance Sheet (Segment I)

Preface: “One’s destination is never a place, but always a new way of seeing things.” — Henry Miller.

“Success is about dedication. You may not be where you want to be or do what you want to do when you’re on the journey. But you’ve got to be willing to have vision and foresight that leads you to an incredible end”. — Usher

Navigate Business with a Good to Great Balance Sheet (Segment I)

Credit: Jacob M. Dietz, CPA

Where is your business, and where is it going? Good to great financial reporting helps answer these questions, but too often the accounting records of a business cannot be trusted because of inaccuracies. If you want more accurate numbers, take the time to clean up your balance sheet. Trying to navigate a course for your business using inaccurate financial reports can be like trying to navigate with a 50-year-old atlas. You may miss your intended destination on the journey. Alternatively, you might reach your destination, but it may take you on a long route. Using accurate financials can help you reach your goals on your journey.

General Principals

If you crave an accurate profit and loss statement and statement of cash flows, start with an accurate balance sheet and end with an accurate balance sheet. If the balance sheet is wrong, then the profit and loss statement and the statement of cash flows may be wrong as well.

If the balance is wrong, how do you fix it? Begin with the beginning balances. Generally, treat the balances that were used to prepare the last tax return as correct. If the tax return contains significant problems, however, then consider starting with balances used for an earlier tax return. For this example, assume that there are no known problems with the last tax return. Let’s explore how to generate accurate balances.


The first part of the balance sheet lists what the company owns. Accountants call these items assets. Assets include bank accounts, inventory, accounts receivable, etc. Verify that the beginning balances for the year equal the ending balances used for the tax return. In a balance sheet, the asset ending balance for the previous year is the beginning balance for the current year. Sometimes accountants adjust the balance sheet when preparing the tax return but don’t adjust the company’s accounting records. If the beginning balances do not tie, adjust the balance sheet dated at the end of the previous year to tie the beginning balances to the ending balances used for the tax return.

What adjustments might be made by an accountant but not entered in a company’s accounting records? Accountants frequently adjust inventory at year end through cost of goods sold. If your accountant adjusted inventory for the tax return, but that adjustment was not made in your accounting records, then adjust your inventory to match the inventory that was used on the tax return. Accountants frequently adjust depreciation when preparing a tax return. Depreciation adjustments affect the balance sheet account Accumulated Depreciation. If Accumulated Depreciation in your accounting system doesn’t match the balance sheet used for the tax return, then adjust it to match.

If all the beginning balances match the ending balances used on the last tax return, examine the ending balances of the period being considered. A balance sheet is a snapshot of a company’s finances at a specific point in time. It is therefore important to know which date is being considered. For this example, assume that the balances are for December 31. Examine every line item in the asset section of the balance sheet, and consider if it is accurate.

Start with cash. If petty cash is listed on the balance sheet, is it accurate? If there is only $25 in the petty cash drawer, but the balance sheet says $1,500, then adjust petty cash to match the counted value. If an item is small, judgment can be used regarding how much verification to do. For example, if petty cash says $45, you might decide to skip counting petty cash since it is insignificant.

Verify the ending balances for bank accounts. Each account should have either a bank statement or a bank reconciliation that ties to the amount on the balance sheet. If a checking account has outstanding checks, review the outstanding check list to see if there are any old items there. For example, suppose there are 2 checks listed from 11 months ago. Why did those 2 checks not clear? Were they duplicated in the accounting system?

If there is inventory on the balance sheet, is it counted regularly? Many companies need to count inventory regularly or else the balance will be incorrect. If the balance differs from a physical inventory count, then adjust the balance to match the count.

When inventory is adjusted, the other side of the adjustment is cost of goods sold, which is on the profit and loss statement. If the beginning and ending inventory balance is not correct, then cost of goods sold may also be wrong, leading to an incorrect profit and loss statement. Therefore inventory, a balance sheet account, impacts cost of goods sold on the profit and loss statement.

If the company has accounts receivable (AR), examine an aging report for accuracy. Does the report list amounts that will never be collected? Consider if any AR should be written off as bad debt.

If there are other items in the asset section of the balance sheet, consider if they are accurate. Also, consider if there are items that are not in the asset section that should be. For example, did the company loan money to another company? If so, ensure that the loan receivable is recorded in the accounting system.

Segment I Summary: Where is your business, and where is it going? Good to great financial reporting helps answer these questions, but too often the accounting records of a business cannot be trusted because of reporting inaccuracies. The above steps as a good beginning step, with the guidance of your CPA, can begin to create an accurate map of your business financials.

Working Capital Tools for Successful Business Performance (Segment V)

Working Capital Tools for Successful Business Performance (Segment V)

Credit: Donald J. Sauder, CPA, CVA

 Looking Towards the Future

Working capital management is imperative to successful entrepreneurship because agreement on its relevance is a real deal when transitioning business ownership. Working capital requirements are often a key valuation feature in business exits.

Let’s look at some relevant marketplace data from Keystone Business Transitions for confirmation:

  • You are far from the only fish in the sea. Estimates indicate that there are approximately 7.5 million business owners in the United States, and 65% of survey respondents planned to leave their company within a decade or less. That could result in a glut of companies on the market, driving down valuations and giving new leverage to buyers.
  • If you are a Baby Boomer (born between 1946 and 1964) the generation following you is not nearly as big so expect far more sellers than buyers in the marketplace. This too, adds to the glut.
  • Even during boom times less than half of the owners who tried to sell their business actually were able to sell.
  • Unless your company is superior to its competitors because there’s something about it that a buyer can use to make more money than you do (or other businesses in your industry do) a rising tide is going to lift you only as much as it lifts that glut of competitors.

If three out of every five businesses plan to sell in the decade, the a superior business should have adequate working capital levels to gain an edge in the increasingly competitive transaction marketplace.

If your business lacks adequate working capital, at best, your business will only confabulate with regards to exit planning because it will not have the cash available to appropriately prepare qualified successors for ownership, e.g. adding and developing partnership/successor trainee(s),  or pay advisors to gear-up the business for  a successful sale, and further, substantiate that your business has an appropriate [any] value for a vertical or horizontal industry integration, i.e. even the tykes like the big fish; and those small fish, why bother right?

Entrepreneurship can be likened unto the Parable of the Talents in Matthew 25. Your business is an alike talent. There is risk, but if you’ve counted the cost, and faithfully apply your expertise, there are often rewards, i.e. your working capital levels will flourish. Similarly, your working capital levels will likely lead to entropy if you or your employees do not put diligent effort forth to continually develop the business.

It is advised to measure working capital levels, i.e. how many fish you have, and how many fish you need for the month, to keep the business continually flourishing financially. If your business faces continual pressures on working capital levels, your advised to get advice [early] on how you too can develop adequate working capital balances with improved business processes, communications, and strategies for successful business performance, e.g. acting [quickly] on working capital concerns improves your probabilities of being a long-term profitable servant.

Businesses succeed because of others, i.e. customers and clients. Some businesses cajole for development, and for others, “Honor lies in honest toil” to quote Homer. Yes, absent a customer(s) or client(s) to transact with in the marketplace community, their would be no business at all; people needs businesses, and businesses need people. Every big fish, began as a small fish, and the big fish are the result of a conducive environment i.e. working capital levels always sustained developments.

While the unprofitable servant likely didn’t realize he should pay an advisor, in addition, he took zero action towards profitability. If you’re investing in your future and your businesses future, you’re likely not an unprofitable servant.

Working capital and sparkling water have shared a value. Too few realize how precious it truly is. Effective management of working capital and the effective management of operating capital and the cash flow cycle is imperative for successful business performance, e.g. the fish will flourish and you will too.

Adequate working capital is your businesses sparkling well. If you’re one of three out of five entrepreneurs transitioning ownership in the next ten years, you’re now advised why you should start investing in the necessary financial tools to measure and manage working capital.


Working Capital Tools for Successful Business Performance (Segment IV)

Preface: Prevention of backsliding in already optimized working capital levels, and developing deeper and more conservative convictions on managing working capital to encourage the life of a more successful financial business environment, are truly inherent skills associated with decades-long successful entrepreneurship.

Working Capital Tools for Successful Business Performance (Segment IV)

Credit: Donald J. Sauder, CPA, CVA

Working capital management has two non-financial centric benefits. 1) To prevent backsliding in already optimized working capital levels, and 2) Developing deeper and more conservative convictions on managing working capital to encourage the life of a more successful financial business environment.

The discredit of the merits of working capital management is often par for business, until a shortage results in acute financial pains. In these scenarios, an awareness of the appropriate steps to take to manage and alleviate that financial pain, work to restore the financial vibrancy of the business. While those steps are not the subject of this article, at those time, few financial advisors measure working capital as a key financial metric. While that is not necessarily a mistake entirely, from an accounting standpoint, meticulous financial management and assessment of historic data, e.g. working capital measurement, will highlight changes, and bold concerns with organizational communication and cohesiveness, customer service, and marketplace conditions (i.e. customer inventory purchasing characteristics.) These are common quantifiable concerns that lead and precede extensive working capital atrophy.

Abrupt changes in working capital management such as extending payment terms on vendors from 15 to 30 says to improve the cash conversion cycle, can result in increased prices on purchases, and changes in vendor terms. Reducing inventory levels can lead to forfeited sales revenue, and customer atrophy. With appropriate data, chief financial officers can support these technical parameters to manage onboard assets, and unboard ancillary cash requirements.

It is of note to ensure that the data gathered is not a burdensome or intensive effort. The data collection is usually facilitated with IT systems that intuitively analyze and identify key parameters of both financial and non-financial data to provide informative data maps on customer activities. There is no business without sales. Data driven sales metrics lead to a greater appreciation of what drives customer revenues that are either recurring or discretionary.

Too often a lack of appropriate attention and guiding convictions towards the value of working capital management oversight, results in navigational challenges when financial turbulence occurs. Entrepreneurs cannot appreciate that in formative years they’ve run the entire business from an intuitive sense. Then when (the entrepreneur) begins to develop the business beyond what they comfortably can manage individually, they eventually face pressure because they do not have proven processes in place for monitoring delegated tasks, nor a process to track key performance data. As key persons revolve, the unattended monitoring of processes from a data standpoint, that can result in atrophy of working capital, eventually leading to financial turbulence.

Importantly, when a business is experiencing atrophy in working capital levels, if the business has not identified and quantified the root causes of backsliding performance, often the safest approach is to immediately scale back business activity as opportunity permits, to a more manageable level. Following re-stabilization, then develop processes of data management both financial and nonfinancial to effectively manage operations, and resulting working capital adjustments. Secondly, oftentimes businesses in turbulence need bolstered with working capital. Minimal risks on the additional credit is imperatively prudent.

Businesses that are solidly established from a working capital perspective, often have developed valuable convictions, and disciplined themselves to invest the time and have devoted proactive attention to prevent backsliding and atrophy of working capital levels, accomplished with timely measurement and reflections on historic, current and future data, and communication of likewise performance metrics. The big-ticket items on management include – inventory, customer deposits, and accounts receivables and payables.

Research at Harvard Business School by Lynda Applegate, Janet Kraus, and Timothy Butler takes a unique approach to understanding behaviors and skills associated with successful entrepreneurs. “The entrepreneurial leaders we know are constantly searching for tools that can help them become more self-aware so they can be more effective,” Kraus explains. “This tool is going to be uniquely useful in that it was specifically developed to help entrepreneurs gain a deeper understanding of the skills and behaviors that they need to be successful.”

Prevention of backsliding in already optimized working capital levels, and developing deeper convictions on managing working capital [conservatively] towards building a more successful business, are truly inherent skills associated with successful decades-long entrepreneurship.

Working Capital Tools for Successful Business Performance (Segment III)

Preface: Don’t tell me what you value, show me your budget, and I’ll tell you what you value.” –Joe Biden.

Working Capital Tools for Successful Business Performance (Segment III)

Credit: Donald J. Sauder, CPA, CVA

Working Capital Measurements    

Working capital is an easy calculation (current assets minus current liabilities equals working capital). Working capital measures the operational liquidity level of a business. Currents assets are primarily the cash and equivalents accounts, accounts receivable, vendor prepayments, and inventory. Current liabilities are primarily accounts payable, credit cards, line of credit, tax liabilities, accrued expenses, customer prepayments and deposits, and current portions of debt.

To accurately measure working capital, it is necessary to have accurate financials with appropriate accountant oversight to classify accurately current and noncurrent assets and liabilities. The current ratio applies the same financial numbers as working capital, yet instead of subtracting current liabilities from current assets, the current ratio divides current assets by current liabilities. Typically, a current ratio should be greater than two and likely 2.5, to be solidly established from an analytical measurement metric.

Working capital measurement and management are synonymous; an analytical approach to monitor a business’ capacity to continue operations with sufficient cash flows and to pay operating expenses and satisfy short-term debt obligations.

Sauder and Stoltzfus, and an entrepreneurs CPA firm, has developed a working capital grading tool to help clients measure optimal working capital levels, i.e. how much is enough when discussing working capital? Let’s call it the working capital grader.

Working capital seems easy enough to calculate. You look at your financial statements and subtract current liabilities from current assets. If you should have the financial accuracy to calculate the balance, the numbers independently, do not provide much analytical guidance. Tracking the balance from consecutive period to period will provide a data map, but you need to know, “Do you have enough yet?”

Numerous business owners have an intuitive feeling on working capital levels, but quantifiably grading working capital provides understandable and mathematical measurement where your business is at now, and where your business working capital could and should be.

Here’s how we grade working capital at our firm. You can do math or follow along (current assets minus current liabilities is the formula.) Now contrasting that mathematically to the profit and loss statement, measure your direct labor expenses,+ operational or general and administrative expenses on a quarterly basis, e.g. what do you pay in direct labor expense or general and administrative expense, on average, every three months?

A business with a direct labor expense of $1,000,000 per year, you would multiply the twelve- month fiscal year number by 0.25; that calculates to $250,000 per quarterly ($1,000,000 * 0.25). If your operating expenses or general and administrative expenses are $1,200,000 for the twelve-month fiscal year, then you would multiple that balance by 0.25 to arrive at a calculated $300,000 ($1,200,000 * 0.25). The greater of those two numbers is your optimized working capital or $300,000, e.g. your business is a solidly pillared if you have the greater of these two numbers in the working capital formula.

If you have working capital in-excess of the calculation your business can take on additional risk to safely develop the expansion of operational activity.

Now if working capital (current assets in the hypothetical business are $900,000 and current liabilities are $725,000) at $175,000, the $175,000 compared to the optimized $300,000 provides an accurate measurement and comparison; $175,000 is what is; $300,000 is the goal for optimization.

Here it is, the grading tool:

  1. 35% equals one month of working capital
  2. 70% equals two months of working capital
  3. 100% equals three months of working capital.

In the above calculated working capital scenario, the 175,000/$300,000 is a lackluster 58% grade. If your business working capital grade is below 5%, your business likely needs immediate help from “Now Man Central”. On the other hand, the $125,000 increase required from $175,000 to achieve $300,000 can be obtained with additional earnings and profits retained in the business, or long-term amortization of say a line of credit.

For a well-managed business, it is an achievable goal to work towards, and exceed a 100% working capital grade; For entrepreneurial businesses with optimized working capital at 100%, say  “Happy Birthday!”

Now comparing this to the current ratio; the current assets of $900,000 divided by $725,000 of current liabilities equals a current ratio of 1.24. A current ratio of greater than 2 would require more than $1,450,000 of current assets say in this hypothetical calculation with no changes in current liabilities.

Typically, as an entrepreneur builds equity with profitable earnings, liabilities decrease as they are paid, and equity increases. Therefore, the measurements and grades improve with time. Startup business ventures should appreciate that their largest risk is liquidity, i.e. measured as working capital.

Working capital tools advisedly should be continually applied and monitored for businesses in every industry.

Summary: “How many millionaires do you know who have become wealthy by investing in savings accounts? I rest my case”. –Robert G. Allen