Last episode, I shared my insight on the starting point when interpreting a balance sheet. I also explained assets as I would to a six-year-old. The topic is - How to read and interpret a balance sheet- and this is Part 2
I will continue today with Liabilities.
What are liabilities? Recall I said assets are anything you own? Well, Liabilities are the opposite. They are anything you don’t own. They are money owed to other people. So, in our example of the six-year-old, a liability would be if she bought the big lemonade jar for $20 as opposed to $10. That means she would owe $10. Now, if the snack shop agrees that she can pay the $10 within a year, that would fall under current liabilities. However, if it is agreed that she can pay after a year, that would be a long-term liability.
Now, generally, the more of your liabilities you can have under the 'long term' category, the better for your business. And I will explain why. If it is agreed that our little girl pays after one year, it means she can sell lemonade for 2 summer periods as opposed to one summer. This would mean she can turnover the ingredients many times more and therefore sell many times more and make more money before she pays the $10 owed. So, that’s better for her business.
This is why you should negotiate longer-term payment terms with your vendors, if possible. As long as the business relationship is mutually beneficial, this arrangement would be a win-win.
Now, when the arrangement is such that you need to pay the vendor under one year, the liabilities are usually called ‘Account Payables’. Account payables involve activities such as receiving, registering, and processing vendors’ invoices up to payments of the invoices. The account payable process starts just after the completion of the procurement of goods and services and ends with payments to vendors for goods and services bought.
Why should you bother with this? Isn’t this the job of your accountant? Well, you’re right it is. But, paying attention to this and understanding it can save you significant cash in your business. After all, what harm can a 2nd level review of what your accountant is doing do?
Paying attention to account payables and ensuring the function is optimized ensures that you can pay your liabilities on time, for the correct amount, to the correct people while minimizing the risk of fraudulent or incorrect payments. It also ensures that vendor balances stated in the Balance Sheet are accurately recorded. For example, a good practice is that - Once an item has been purchased, the good receipt process kicks in. The purpose of the goods receipting process is to confirm that goods or services are received to quality and quantity based on what has been ordered. Goods receipting, if done appropriately, will prevent your business from paying for purchases or services that have not been delivered to satisfaction. This can prevent money from being wasted.
I will stop there for now and we will continue on next episode. Until then, let’s continue to learn together and be encouraged to keep on connecting.
This blog is about personal development for entrepreneurs based on the principles of fairness, compassion, and commitment. This includes the practice of 'speaking' positive affirmations, which can be a powerful tool to support self-development. Hopefully, you’re impacted positively in some ways. As we all know, personal circumstances are quite different. So, I encourage you to apply the lessons in line with your own context. Do continue to “Hola” to connect with people and remember “Let's continue to learn together and be encouraged to keep on connecting”.