Improving Your Balance Sheet

April 13, 2006

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Although steps can be taken just prior to the balance sheet date (generally, year end) to improve it, you should be aware of how your actions and decisions throughout the year affect the "balance sheet appearance" of your company that may be presented to outsiders.

Often, the individual balance sheet items can be improved to give a better-looking overall picture. For instance, cash balances often can be improved simply by retaining cash collected on receivables until after the balance sheet date, rather than promptly spending the money.

Another area to watch, if you manufacture goods, is inventory. Since finished goods are more easily converted to cash than are raw materials, and also have a higher value, converting more raw materials to finished goods before the balance sheet date looks better when presented in the financial statements. Whatever your business, you may want to hold off on writing off receivables as uncollectable bad debts, or writing down marketable securities to reflect a decline in value (assuming the delays are justifiable).

Sometimes year-end planning to reduce taxes may be in conflict with year-end planning to improve financial statements. This is because higher income looks good on your financial statements, but can cause you to pay more income tax. In such a case, you may have to choose between paying higher taxes to make your company's financial statements look better, or foregoing improved statements to reduce taxes. Depending on the business and its needs, lower tax payments are not always your best choice.

The fact that a business owner can take steps to improve the balance sheet's appearance illustrates one of the shortcomings of the statement. To the extent that it can be manipulated, it becomes less reliable as an indication of a business's true financial condition.

If you are ever in the position of considering whether to buy or invest in another business, be sure to look beyond the balance sheet!

Besides improving the individual items shown on your balance sheet, you can also improve its appearance by improving your business ratios (or the relationship between certain items). To illustrate how you can do this, consider four key business ratios derived from balance sheet figures. Two deal with the liquidity of the business (current ratio and quick ratio) and two deal with the management of business debt (debt-to-equity and debt-to-assets ratios).