The balance sheet is a snapshot. It’s a moment in time, that answers the question that I believe is more important than “how much money did I make?” Understanding the balance sheet is the real key to understanding how to grow your business. You cannot grow a business with profits alone, because they can be taken out in the form of distributions. Your time billing and accounting software should have the ability to run this report.
You must retain your profits, and when they’re retained, you start building the Equity section of your balance sheet. When you build the Equity section of your balance sheet, you are building the net worth, or the book value of your business. When you take the time, and spend the money on time billing and accounting software, it’s worth while to start building a strategy around taking a closer look at this.
There are a few ways to increase the equity of your business, and it amounts to a few, simple strategies. It’s important that your time billing and accounting software gives you the ability to look at these things. In short it means you need access to key accounting reports like the balance sheet, profit and loss, and the statement of cash flows.
First, you have to make a profit.
Next you have to build a strategy around increasing assets.
This means that when you spend money, you want to “invest” as much as possible into things that increase assets. This doesn’t mean you spend frivolously just for the sake of increasing assets. It means, for example, on the choice of “lease or buy,” try to lean towards a buy. This puts an asset on your books, whereas, leasing simply adds to your expenses. The only reason for leasing over buying would be tax considerations.
Finally you have to minimize your liabilities.
This doesn’t mean you should never take on debt. I want to encourage you to look closely at WHY you’re taking on the debt. The way to manage debt properly, is to look at what your debt to equity ratio will look like, once you’ve taken on the debt. Look at your total debt divided by your equity on a comparative basis each month, and monitor the trend. Does your time billing and accounting software make it easy to do this?
Here’s the cycle of debt to equity
You borrow money.
You should invest that money into assets (so it doesn’t dilute equity). Remember that assets – liabilities = equity. Borrowing the money won’t affect your equity, initially, because the borrowed money goes into your bank account. That increases assets by the exact same amount that you increased liabilities. Next you start paying interest. That reduces net income, which reduces equity. So your return on investment based on what you invest that money in, has to be greater than the interest you’re paying on the debt. Otherwise you’re losing money, and with that, the value of your business is decreasing. This is why it is so important to have a good reporting area within your time billing and accounting software. You have to be able to look at this stuff frequently.
The assets you purchase should help you increase profits. This could be machinery and equipment, that help you increase efficiency. That increased efficiency should help increase profits. Increased profits, increase equity. Use those profits to pay down the debt, and that increase in equity becomes more and more permanent.
Too many people think that their accounting and bookkeeping only serves the purpose of getting a tax return filed. The above kind of strategic thinking based on the balance sheet is where the REAL value in spending time and money on your time billing and accounting software comes in.
The financial reports are, or should be, the ultimate output of your time billing and accounting software. Find out if you have the right tools, and then learn how to use them. If you’re not an accountant, then it probably makes sense to schedule some time with one to go over these kinds of reports. Learn how to generate them, and learn how to analyze and understand them.