Is your business really booming?
Or is your hefty bank account a smokescreen for a house of cards on the edge of collapse?
Are you confident that your P&L is telling you the real story?
Here’s the simple truth: An inaccurate balance sheet will wreak havoc on your P&L.
Let’s investigate just how important it is to clean up your balance sheet so you can have a dependable and accurate perspective on your bottom line.
- Substantiate every balance. It’s simple. Every posting level account on the balance sheet must be reconciled. Without this critical step, your net income could be meaningful, if not disastrously off.
- Learn and recognize the difference between NET INCOME and CASH FLOW – a frequent pitfall for expanding businesses.
Net Income is a measure of a company’s profitability.
It considers cash and non-cash items like depreciation and interest, but it rarely ties to or “matches” the bank balance. We see this misunderstanding among many of our newer clients, and these two measurements must be precise.
Cash Flow looks at the actual movement of cash over a period of time.
A company needs to have a solid grasp of how the cash flows in and out of the business on a daily, weekly, monthly, and annual basis.
Cash flow will be dramatically impacted by unpaid invoices (A/R), principal debt service, credit card payments, and many other balance sheet items whose flows will affect the bank balance but not necessarily net income in the same period.
Understanding this is foundational to making informed financial decisions.
Let’s see it in action.
Here’s a real-life example of how this misunderstanding ended up working out in the client’s favor.
When the client came to us, they were panicking. Although their sales were steady, and the bank balance seemed healthy, their Net Income (bottom line) was a daunting -$300,000 – certainly an alarming situation.
Our team started with the balance sheet. Sure enough, a line item called “Customer Deposits” was buried on the balance sheet grouped quietly under “Other Liabilities.” The balance was almost exactly $300,000.
The client’s bookkeeper had parked deposits for events on the balance sheet and never actually recognized the revenue when it was earned.
The cash had been received, but the revenue had never made it to the income statement, hence the terrifying bottom line.
Turns out our client was breaking even, not losing money! The balance sheet was wrong, and therefore, so was the P&L.
Here’s another example.
A client came to us desperate for help facing an accusation of money laundering. Upon quickly glancing at the balance sheet, we noticed the cash balance was -$500,000, and the credit card balance -$800,000. Obviously, this was incorrect, but we were stunned that no one had reconciled these accounts.
The former accountant had gravely misunderstood the bank sync functionality in QuickBooks, and assumed that bank feeds automatically handled reconciliation. FALSE!
API connections can disconnect, requiring historical transactions to be re-uploaded to the banking portal once the connection is restored. An astute accountant will carefully omit transactions already posted to the financials to avoid the risk of duplicated expenses.
Unfortunately, this accountant posted the transactions multiple times to the financial statements but never took the time to match them to the published bank statements (i.e., reconcile). Big OOPS.
A straightforward bank reconciliation would have flagged all uncleared transactions, revealing the issue.
In this case, financial statements were turned over to the opposing counsel before verifying the balance sheet. Luckily we could right-side our client, and the case was ultimately dropped.
Here is your takeaway:
These examples may seem minor or obvious, but this is about much more than highlighting simple bookkeeping errors.
The point is to underscore how businesses expanding without a professional finance function can inadvertently neglect the balance sheet due to a lack of understanding.
This simple oversight can have a huge impact on the trajectory of your business. And often, the solution is much simpler than it first appears.
Clean up your balance sheet. Know your numbers.
