What Does a Strong Balance Sheet Look Like – Cont’d

On our previous blog, we not only discussed and explained what a balance sheet is, we also talked about what constitutes the left and right side of the balance sheet. We discussed the meaning and classifications of current and non-current asset, liabilities and equities. We also discussed that assets must equal the liabilities and the owners’ equity. In our previous blog, we gave tips on how to improve the balance sheet.

And the third way to improve the balance sheet, is that you need to pay close attention to inventory control. When you hold a lot of inventory, your business’ inventory will result in a large bearing on your balance sheet. Too much inventory on your business’ balance sheet can create several significant risks that include losses being added onto the balance sheet and increased risk of inventory becoming obsolete or damaged. Moreover, holding more inventory than you need means that capital is tied in an as-yet productive asset rather than generating cash flow or improving your business’ financial stability.

The fourth way is to reduce the staffing cost. In the early stages of setting up a business, staffing costs can contribute a substantial part of business’ operating expenditure. Thus, employing only a realistic strength of staff can boost business equity. You can gradually increase staff strength as your business grows, rather than in anticipation of a future boom.

Now that we know what makes up a balance and  we also have a grasp of the ways to improve our balance sheet, let us now take a look at what a strong balance sheet look like. And to do that we have to do a critical analysis of the balance sheet. And it is only after this step, we can say or conclude that a balance sheet is strong or weak. Various financial ratios can give a better sense of the company’s liquidity as well as its ability to generate cash flow. Useful ratios used to analyse balance sheet are current ratio, debt ratio, debt to equity ratio and lastly, days sales outstanding ratio (DSO)

The current ratio is a liquidity ratio that measures a company’s ability to pay short-term and long-term debts.

Current Ratio = Current Assets / Current Liabilities

The debt ratio is a financial ratio that measures the extent of a company’s leverage

Debt Ratio = Total Liabilities / Total Assets

Debt to Equity Ratio indicates how much debt a company is using to finance its assets relative to the value of shareholders’ equity

Debit/Equity Ratio = Total Liabilities / Shareholder’s Equity

Days Sales Outstanding Ratio is a measure of the average number of days that it takes a company to collect payment after a sale has been made.

DSO Ratio = Accounts Receivable/ (Annual sales / 365 days)

Having more assets than liabilities is the fundamental of having a strong balance sheet. Further than that, companies with strong balance sheets are those which are structured to support the entity’s business goals and maximise financial performance.

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