Understand the Balance Sheet

Part of the monthly management accounts will be a balance sheet, whilst the profit and loss account is a measure of trading activity over a period of time (usually a month for management accounts)the balance sheet is a snap shot of the business at one point in time (the last day of the period). Whilst the balance sheet on it's own provides important information about the business if the report also includes the budgeted balance sheet figures and the previous months figures this provides additional information as you can compare your actual balances to your budget and look to understand the causes of any meaningful variances. By also having last months figures you can look for movements in the balances and seek explanations for any concerning movements. Some of the movements may be quite easily explained as timing differences, for example if the creditors balance is much higher than normal as at June 30th a large payment run of creditors paid on July 1st would quickly explain the movement and the balance would be back to an expected level, however not all movements can be explained so easily and a greater degree of investigation may be required.

Here are a few examples of items needing to be investigated:-
Fixed asset values increase - what has been purchased?, has the correct proceedure for asset purchase been followed?, was the purchase agreed in the budget?
Stock - increases in the amount of stock held can quickly soak up cash, so any increase in stock levels needs to be monitored closely. Compare the stock level to budget and look at the stock balance over the last few months to see if there is a rising trend.
Debtors - increases in debtors could suggest customers are taking longer to pay, check the budgeted figure and the investigate the reason for the increase.
Creditors - increases in creditors could mean you are not paying suppliers on time leading to the posibility of production being held up because of supply shortages and possible loss of reputation.
Bank - increases in bank overdrafts need to be investigated, ideally you should have sufficient control over your day to day cash situation so that you are fully aware of your cash position before you see the month end balance sheet.

Previously in the blog we have looked at some balance sheet ratios which give important information about asset usage and the liquidity of the business, these ratios should also be compared to budget and the previous months position.