10 Red Flags on your Balance Sheet that will Cause you Harm
Every business owner knows how much money they are making. Either by knowing their bank balance or by calculating their profit or loss. This is not the only thing banks and funders look at. If you don’t have a proper balance sheet, you won’t be able to get financing and it looks like your business is not financially healthy.
Here are 10 things I would look out for when reviewing a set of accounts that I know will be submitted for financing:
1) Bank balance in the credit – If you owe the bank money, why would anyone want to loan you money? Petty cash can’t be in a negative. It is physically impossible. Consider the accuracy of:
- Expenses accounted for
- Items that have VAT inputs on them that can be claimed back
- Has a cash count been performed? If not, possible control weakness.
- Is the bank reconciling? If not, why bother? These people don’t know what they are doing
2) Shareholders’ loans in debit – A Shareholder’s loan in debit means the shareholder has distributed or paid themselves money without paying the income tax on that. It is viewed as distributions paid over a period. If the shareholders can’t pay themselves a proper dividend, why should a financer invest in this business? There is probably a tax implication that has not been accounted for properly. Do I want to get involved with this? What are the terms for repayment?
3) Shareholders’ loans in credit – You, as the shareholder, have put money into the business, but why? Is it perhaps because of salaries not yet paid to you? If you can’t afford your salary as the director/shareholder, why should a financer invest in your business?
- Is the company not able to support itself?
- Get external funding and pay it off on terms. If you can’t? Do I, as a financer, want to?
4) Liabilities in a debit/negative – This means incorrect posting has been done because creditors can’t owe you money. If so, then they are debtors and account and disclose for it properly. It really does affect the integrity of the balance sheet.
5) Assets in a credit/negative – This means incorrect posting has been done. You can’t have a negative asset so go look at what caused this to be negative. Does the company have a fixed asset register?
6) Opening balance suspense account – This means something, somewhere is not balancing or captured and the integrity of the trial balance and accounting information is questionable. If you don’t know where to allocate something, how should I? Should I invest in a company that doesn’t know what is happening in its business?
7) Unchanged balances for longer than 2 years i.e. other creditors – Why not pay your creditors? If you have, then this was incorrectly posted and the integrity of your balance sheet is questionable. If it hasn’t, no way am I investing in such a business.
8) No fixed assets – Most businesses need a computer, printer, office furniture etc. If not, why not? Maybe a fixed asset is not maintained as is required by the companies act? Or perhaps all the assets have been written off?
9) Retail and wholesale business without inventory – No stock take was performed and all expenses were accounted for in the income statement. This means:
- Income tax expense will be understated and cause legal implications.
- The assets are undervalued i.e. the shareholders’ value is understated.
- The liabilities might be understated because the creditor might not have been accounted for.
10) Net assets in a negative/equity is negative – The company is factually insolvent and nobody wants or will invest/give funds to a company that is factually insolvent.