Step 2. Review Your Assets
Just like when it comes to personal finances, assets are all those essential things you use to maintain your living: a house or apartment, a car,and even money on your credit card. Some of these things you may own, others may be borrowed.
The common characteristics of your assets (both personal and business) are that you can financially benefit from them now or in the future.
Reading the Balance Sheet starts with reviewing the current assets section.
To start with, current assets are the most liquid assets your business owns.
Liquidity is an ability of an asset to be converted into cash.
For example, an office building is not a liquid asset because it may take a lot of time to sell it and get cash instead. However, inventory is highly liquid as it could be converted into cash within a short period of time.
Current assets usually comprise of:
- Cash on hand and in your bank accounts. Also, this includes cash equivalents that can be quickly converted into cash.
- Inventory you have in your warehouse – we will review this more closely in the next step.
- Accounts receivables – amounts that are usually due in 30 days (depending on terms offered to customers), therefore, classified as current assets.
- Prepayments – money you’ve paid in advance and are expected to receive some service or product in the nearest future. For example, if you’ve prepaid for the office rent for one year this is classified in your balance sheet as a current asset.
- Accrued Revenue – what you earned but haven’t invoiced yet.
The next section you will see while reading the Balance Sheet is Non-current Assets that includes:
- Fixed assets are physical property you own and have a useful life longer than one year.For small e-commerce businesses fixed assets on the Balance Sheet may consists of a single computer.
- Long-term securities: Investments that can’t be sold within one year.
- Intangible assets are used in the operations of the business but have no physical substance. Examples of these are patents, copyrights, and franchises.
As you can see the assets are classified based on the time required to convert them into cash. Analyzing the assets structure could be useful for assessing the company’s solvency.
Step 3. Inventory Balance Analysis.
We would like to highlight an inventory overview as a separate step of the balance analysis. If you are running an e-commerce business, then the inventory cycle is the most crucial thing. Buying too much inventory (or the wrong products) may cause losses. At the same time, if you don’t buy enough of the right products you can lose money again. You simply wouldn’t be able to fulfill the potential demand and therefore give the way to your competitors.
As an e-commerce business owner, your task is to find the right quantity of the right products to sell. Your success as an e-commerce seller starts with an understanding of inventory turnover.
Inventory Turnover Ratio is calculated as COGS divided by the average inventory for a period. So you should look both at the P&L and Balance sheet to pick up these numbers. As a result, you’ll find out how many times inventory is “turned” or sold during a period. The higher this ratio is the better it is for your business.
Let’s look at it through a practical example:
In the beginning of the year, opening inventory was $ 45k, the closing inventory was $52k. The annual COGS reported was $300k.
First of all we should calculate the average inventory:
($45k + $52k)/2 = $48.5k
Then simply divide COGS by average inventory:
$300k/$48.5k= 6.18
At first glance, this ratio doesn’t tell you a lot: is this result of 6.18 a good or a bad indicator?
Let’s do the following to get a better understanding:
365 days/6.18 = 59 days.
So, the ratio of 6.18 means that it takes 59 days to sell ALL our inventory. In other words, your inventory took 6 “turns” during the year.
Inventory turnover can be one of the most important financial ratios for e-commerce business owners to monitor. It measures the liquidity of your inventory and can help to determine how to increase sales. Low inventory turnover means that you invested too much in inventory. You spent too much money on acquiring a product you can’t sell out quickly. Also, don’t forget about the costs associated with the storage of these items.
In this case, you are losing out on potentially more profitable investments.
With a better understanding of the Balance Sheet, you will have better answers to the crucial questions each e-commerce seller searches answers for:
- Which products are selling the best?
- How many do you need to maintain stock levels?
- How much inventory to order next time?
