Remember, according to Bloomberg, 8 out of 10 entrepreneurs who start businesses fail within the first 18 months. A whopping 80% crash and burn. And yes, the primary reason companies fail is they run out of cash.
Warren Buffett says, “The language of business is accounting.”
For a guy like me, that is a scary thought.
I have had no formal training in business and accounting. However, because I use other people’s money to grow a self storage business, it got very clear I had better learn.
We have discussed in Episode 304 what your P & L (profit & loss statement) does not tell you and what it does tell you (hint: cash & profits).
In Episode 305, we talked about a report that actually does tell you about the cash in your self storage business and how to read that report.
If you haven’t read those, I would recommend doing so now, so this episode is in context.
Today let’s discuss what for me was the biggest mystery of all financial reports, the balance sheet.
So, if the Profit and Loss statements tell you about the theory of your facilities (or any businesses) profits, and the Cash Flow Statement tell you about the cash in and out of your business in a given time period, the Ballance Sheet tell you about the Things and Stuff in your business.
So, it turns out most businesses own things and stuff.
We certainly do in the self storage business.
What are they?
Well, the buildings are things. Right?
So is the fencing around the facilities. The computers are also things as well.
What else?
Well, it turns out our money is stuff as well. If you have $35,000 in your bank account, that is “stuff” that goes on this report.
The fact on the first of the month (or on the anniversary date of a customer’s move-in, if that is how you are set up), your customers will owe you money.
That is “stuff” as well, according to CPA’s They call that stuff “account receivables”.
All that retail things we sell in our facilities I go on about all the time, it turns out that is ‘stuff” too. That also shows up on the balance sheet.
In accountant speak, they say there are four major parts of “Things and Stuff” they measure.
- Cash
- Accounts Receivable
- Inventory
- PP&E: property, plant, and equipment.
All I know is all of the things and stuff of a self storage facility will fall into one of those four categories. I really don’t care which one they’re in. To me, it is all Things & Stuff.
I finally fingered out that a business will either own or owe on their things and stuff.
So, what would you “owe” in your business?
Well, you owe taxes, right? You also owe the light bill, the insurance bill. You owe the employment taxes for your manager as well as their salary when due.
Those are some of the things we owe. The accountants call it “Accounts Payable” (A/P).
There are also some long-term things we owe as well, right? For example, loans for the real estate with the bank. Now the CPAs don’t call that A/P (accounts payable) for some reason. They call those “owes” Long Term Liabilities.”
I guess the difference is if there is interest. It is called “Long Term Liabilities” if there is interest involved, and if there is no interest, it is A/P.
To me, it doesn’t matter. It is just stuff I owe.
In essence, the balance sheet looks like this:
| Things & Stuff | Owe | |
| Own | ||
Accountants say we own our (1) investment (the money we used to invest in and buy or start the facility), and we own (2) our profits (they call that “earnings”). So, according to them, we own our investment and earnings.
It is a good thing it turns out we own our profits. I guess in some countries, and in other times, we wouldn’t necessarily own our profits.
Now, what is cool is that in the above figure, the “Things & Stuff Side” equals the” Owe” and “Own” Side.
At least, I think that is cool.
I guess that’s why they call it a Balance Sheet. I would much rather call it the Things & Stuff Report.
Now here is where this report finally started to make some sense to me. Let’s say your Things & Stuff equals 10.
| Things & Stuff
10 |
Owe | |
| 8 | ||
| Own | ||
| ? | ||
What you owe is 8. What is the amount of own?
That’s right, it is 2.
You are now already way ahead of many business owners.
Now accountants call “Things & Stuff” Assets. They call “Owe” Liabilities, and they call “Own” Equity, but I like mine better. It makes more sense to me.
That is what is called a Balance Sheet.
The Balance Sheet is like a snapshot. It gives the score of the Things & Stuff in a moment in time in a business. Theoretically, one minute later, it has changed. It is just a score at a given time, like 12-31-2020.
Now one more thing about the “Own” things.
Remember, you own your profits, right?
It turns out that there are two types of profits you own. There are the profits you own from the Profit & Loss (Episode 304). Remember?
Those are profits from a given time period that ends on the day the snapshot was taken for the Balance Sheet report. In other words, if you are looking at a facility to purchase, and you get last year’s financials, the profits should reflect that last calendar year’s profits.
However, it turns out there is also another kind of profit or earnings on this part of the Balance Sheet. It is all the earnings you have made since the start of the company you have not paid yourself or your investors.
If you pay yourself or your investors some of the profits, the accountants call those payments “Dividends.”
I call it profit I paid out.
If you decide not to pay it out and keep it in the company, it is called “Retained Earnings.”
You now have a basic understanding of a balance sheet.
I bet you can now start to look at a balance sheet and get more information about a company than you did before this episode.
Let’s look at something.
Both companies have earnings (or profit) of 4 below, but are these two companies alike?
Company #1
| Things & Stuff
10 |
Owe |
|
|||
| 6 | |||||
| Own | |||||
| 4 | |||||
|
Company #2 |
|||||
| Things & Stuff
1,000 |
Owe | ||||
| 996 | |||||
| Own | |||||
| 4 | |||||
No, they are not alike. Why?
Are their Assets and Liabilities alike? Which company would you rather invest in or buy?
Company 1 can turn a 40% profit on their assets. Company 2 can turn less than one-half of one percent profits on their assets.
But yet, I bet company 2’s assets are worth more than company 1.
Which company is worth more?
Which company is better run?
Can you begin to see things now about a company from their balance sheet you couldn’t before?
You are beginning to translate the accountant’s language into understandable language.
Said another way, you turn numbers into words and a story, simply from looking at a report.
You can also begin to see how all of the different reports (balance sheet, profit & loss statement, and cash flow statement) tie in with each other.
The profits from a P & L show up as something we own on our balance sheet. They are not the amount of money we made or lost. The money, or cash position of our company, is on the Cash Flow Statement.
Our cash either went up or down in a given time period. Our cash could have been used in a lot of ways, but that does not affect what our profits were in the business over that same time period.
When we put all three reports together, the complete story of a company, or of your self storage business, starts to emerge.
Once you can get the story from the numbers, you can then make intelligent decisions about where to push and where to pull on a company and how each movement may turn into more numbers.
You will turn numbers into a story, take action, and turn that action back into numbers.
That is what the 10% of businesses that succeed do.
Let’s become part of that 10%.
We are in an industry that can turn assets into profits and cash better than perhaps any other. That is my relationship to this fantastic business.
I certainly don’t want to screw it up by not making good business decisions because I can’t understand my financial reports.
I hope these last three episodes help you in this area.
Let me know your thoughts.
