Introduction
Operating a successful business is tough. You need to manage cash flow, handle unforeseen expenses, and meet payroll. However, as much as you focus on day-to-day operations and try to make your business grow, there’s one thing you absolutely cannot ignore: your balance sheet. The balance sheet shows how much money your company has available for expansion or paying off debts. Whether you’re a small startup or an established enterprise, the balance sheet gives all stakeholders — employees, investors, lenders — a picture of how the company is doing financially and allows them to project what will happen in the future. What should that picture look like? What makes a strong balance sheet?
Liquidity
Liquidity is your ability to pay bills when they are due, which is why it’s an important concept for business and for investors.
For businesses, liquidity allows you to pay your employees and vendors on time and invest in the business. If a business can’t meet its obligations, it goes out of business. In short, liquidity means having enough cash on hand (or the ability to quickly access that cash) so that bills can be paid when they come due.
For investors, liquidity is what protects them from losing their money if there’s a sudden need to liquidate their investments — that is, sell off their assets very quickly without much reduction in price (also known as “slippage”). The more liquid an asset or investment class is — meaning there are many buyers and sellers at any point in time — the safer it is for investors because they won’t have trouble selling at current market prices when they need money fast
Leverage
Yes, leverage is one of the most important aspects of a strong balance sheet. It can be a good thing, but it can also be dangerous. The key is to use it wisely.
Imagine that you’re opening a new restaurant and have decided to raise money for the business by getting a loan from your bank. The bank lends you $1 million at an interest rate of 5%, payable over 10 years with monthly payments of $50K each month starting two years after closing on the loan terms (the day when they actually give you money).
To repay this loan in full would require 120 monthly payments totaling more than $120K ($1M*5%/12). But if instead of repaying that entire amount you chose only to pay back half — or even less — then there’s no way your business could survive! Your best bet would be to default on the remaining balance, which would put both parties into default with each other and result in them having no relationship whatsoever moving forward!
Profitability
The profitability of a company is a measure of its ability to generate revenue and earnings relative to the amount of capital invested in it. Profitability has two components: gross profit margin and operating profit margin. Gross profit is calculated by subtracting costs from sales, while operating profit equals gross profit minus any additional expenses such as interest on loans or depreciation.
Gross profit margins are determined by comparing the cost-to-sales ratio with competitors’ ratios; if you can sell your product at a higher rate than they do, your margins will be higher than theirs. The most common methods of calculating gross profit margin include using cost information from accounting records or from actual cost transactions (such as purchases).
Operating profits represent only those revenues that are left after paying for all costs associated with producing goods or services — including salaries for employees who work directly on production activities (such as accountants), rent for buildings used exclusively for production purposes (e.g., warehouses), maintenance costs incurred by machines used directly in production processes (e.g., forklifts) and other business expenses necessary to operate efficiently but not directly involved in creating products or services offered for sale through market channels such as retail stores or websites.
Activity
The activity ratio measures the ability of a company to collect its accounts receivable on a timely basis. This ratio is often used by analysts to determine whether or not there are any problems with the company’s cash flow and profitability.
If your company’s activity ratio is too low, this could indicate that your customers are having difficulty paying for services, or it could mean that you are offering discounts so great that your customers can’t justify buying from you. A high activity ratio indicates that customers are paying their bills quickly and in full, keeping your business profitable.
If these ratios seem like they can help you determine whether or not something is going wrong with your balance sheet, don’t despair! There are other ways you can use them:
A strong balance sheet is necessary to ensure that a business has the chance to succeed.
- A strong balance sheet helps your customers, employees, and investors feel secure in their business dealings with you. When your company is well-capitalized and solvent, it’s easier for them to trust you as an organization and keep doing business with you.
- The same goes for suppliers: If they know that they’re going to get paid on time by people who can afford what they’re selling, they’ll be more willing to ship goods or services directly into your hands.
Conclusion
And that’s how you build a strong balance sheet. It’s not easy, but it’s absolutely necessary if you want your business to grow and succeed. Make sure that you’re always keeping an eye on these four factors and that you’re making efforts to strengthen them wherever possible.
