So, You Think You Are Running Your Business!

Copyright 1979

By G. Robert Claypool Vice President and Group Controller Certainteed Corp. Waco. Tx.

f t is probably accurate to state that most businessmen I have a thorough understanding of the income statement relative to their business. After all, the income statement measures performance: the type of performance we want, sales and income. The income statement is watched very closely in most businesses. Are sales increasing? Are expenses in line with volume? Are gross margins holding with product mix, competitive situations and inventory levels? Is operating profit where it should be? Does all of this sound familiar? You bet!

If an equivalent amount of time was spent analyzing the balance sheet (you know, the document that Iists assets and liabilities). most businessmen could avoid financial difficulty or forecast the problems ahead and act to lessen the impact. There are varying degrees of knowledge of the balance sheet and unfortunately, it is too often left to the accountants to manage that part of the profit equation.

Yes, the balance sheet is part of the profit equation! Your net income could grow 1006 this year and that may be satisfactory, but if your inventory also grows 100h, your cash flow could be less and your return on investment could go down. Sound familiar? In too many businesses, it is all too familiar.

When a business is started, two important considerations are prevalent. How much do we have to invest to make a reasonable and acceptable return and will we have enough cash flow to meet our obligations and sustain operations? As the business grows and develops over several years, we must remember these initial considerations and establish and monitor objectives for both.

To successfully manage a business for the long term, we must constantly review and manage both the balance sheet and income statement. They are interrelated documents of information and measurements of performance.

Let's take a hypothetical company, which we will call Building Materials Corporation. Management reviews the income statement and makes the following observation: how

The income statement reflects impressive results for the current year. Net income has increased 280/o on a sales increase of I lol0. Reviewing the balance sheet for the same periods adds another dimension.

Why was it necessary to increase inventory 260/o and receivables 1906 to achieve a sales increase of 110/o? The maximum increase for these two balance sheet accounts should have been l106 - equal to the sales increase. But at the same rate of increase as sales, inventory would show no turnover improvement. If the additional sales were achieved at the same inventory level as the prior year, turnover would have improved significantly. A closer examination of inventory and receivables reflects some important changes.

While sales and income performance was excellent, cash flow was negative requiring a reduction in the previous year cash balance.

Managing the balance sheet can solve cash flow problems. Let's examine what could have happened to the cash balance as a result of the changes in inventory and receivables.

Reduction in cash balance last year to this year Cash would have increased if, Receivables collection period remained unchanged $12,000

If the balance sheet had been managed carefully and both inventory and receivables had been maintained at the same ratios as the prior year, the result would have been $59,000 more cash available. Rather than a decrease in the cash account of $21.000. cash would have increased $38,000.

If the additional sales this year of $300,000 were achieved at the same inventory level as last year, further improvement would have occurred:

Many businesses do not prepare a Statement of Changes in Financial Position, which simply explains the sources and uses of cash or the flow of cash from the income statement to the balance sheet.

Ifyour business does not use this accounting document in conjunction with the income statement and balance sheet, you should start including it in your financial information package.

Awareness of the impact of balance sheet changes is vital to successfully managing your business. The income statement, balance sheet and cash flow statement report on history: what happened last year, last month. Of even greater importance is the necessity to project what may happen next month, next quarter or next year.

A business with a growing sales volume and satisfactory warehouse inventory management should be able to consistently improve inventory turnover. Thus, if the additional sales were achieved at the same level of inventory as last year, $80,000 less cash investment would have been required. The turnover improvement factor would have added $33,000 to the $59,000 cash availability.

Using the information presented, let's determine what happened to cash flow.

Readers desiring .further, detailed information on cash.flow and return on investment can obtain excellent booklets on these sub.jects.from the Certainteed Corp., P.O. Box 889, Waco, Tx. 76703. Include $4 to cover printing and postage; make checks payable to Certainteed Corp. - ed.

The importance of cash requirements planning cannot be underestimated. Careful attention paid to this often overlooked detail can be very rewarding. Rewarding in the sense that the expenses can be controlled and frequently reduced, inventory purchases can be targeted to meet cash availability, better judgment can be made on receivables policy regarding both collection effort and individual account sales and probable trouble areas can be identified in advance.

The source of information required to develop a cash forecast is readilv available from vour current