2010 June: Balancing Act

Danny Mac’s Pizza, Pasta & More isn’t the highest grossing operation in the industry, but owner Danny McMahon accounts for every dollar as if his were a publicly traded company. While a franchisee for the now-defunct Pizza Magia chain, McMahon learned to crunch numbers in ways that helped him understand his business’s fiscal condition, and those lessons remain in use as the owner of his own shop.

“It taught me where I could save money and where others might be wasting money,” says McMahon, whose business is in Louisville, Kentucky. “I’ve been hanging around that breakeven line for about six months, so I have to watch it carefully.”

That “it” is McMahon’s balance sheet, the financial snapshot of his business’s health. The data it supplies tells him his business’s available cash, the value of his inventory, who he owes and who owes him. Humbling as it was to make a $60 profit in February, it at least told McMahon the bills were paid.

“I’m managing it, and at least I don’t have to borrow money any more,” he adds. “My biggest focus this year has been taking care of my own books.”

At his accounting seminars, people often ask Jim Laube, “Why should I even have to look at that?” says Laube, a former corporate accountant and restaurant manager. “Why? Because it tells you a lot about your business … things that a (profit and loss statement) won’t.”

A P&L or income statement details an operation’s profit or loss by comparing expenses and revenue over a specific month, quarter or year. A balance sheet, on the other hand, gives an operator a more immediate view, showing whether the business has the cash to pay its current bills (including taxes and weekly or monthly commitments to suppliers and creditors) and whether those who owe it money are paying on time.

Divided into two sides — assets on the left, liabilities on the right — the balance sheet “tells you how solvent you are by telling you how much working capital you have,” says Robert Langdon, a former CPA who now speaks to business audiences. “The more working capital you have, the better the odds are you’ll be able to pay your bills.”

To mathematical minds like Laube’s, creating a balance sheet is simple, but he knows many operators are uncomfortable with general accounting. And while there’s no shortage of small business accounting software available, none are worth the investment if an operator can’t or won’t use them.

After a well-meaning family member messed up McMahon’s books, he took them over and started using an online program he says gives him all the information he needs. Laube says McMahon’s choice is common, while other less confident operators defer to professionals.

“This is not rocket science, so anyone should be able to understand accounting if it’s explained well to them,” he says. Yet even if you do defer to a bookkeeper or accountant for advice or to wholly manage your numbers, “don’t be intimated or say you don’t need to know this or that because you’ll let the bookkeeper take care of it. That’s when they start to develop little kingdoms and convince themselves they’re invincible because the owner doesn’t know what to ask. It’s up to you to ask lots of questions so you can understand what those numbers mean.”

While a balance sheet provides an instant view of an operation’s solvency, Langdon says it also tells bankers even more when an operator seeks to borrow money. A business’s “current ratio” and its “debt-to-equity ratio,” both gleaned from the balance sheet, indicate whether loaning money to an operator is risky or smart.

“When they’re looking at loaning money to one business versus the other, they’re looking at the odds that one can repay it versus the other,” Langdon says. “What they’re really doing is betting on different businesses to be successful, and (the balance sheet) is where they get those numbers.”

Current ratio (defined as current assets divided by current liabilities) indicates the amount of working capital in the business. If, for example, a business has $75,000 in current assets and $37,500 in current liabilities, it has $37,500 in working capital and a current ratio of 2 to 1. The higher the ratio, the more liquid the business and the greater chance the owner can pay bills.

“But if that ratio is down to 1 to 1, that means you’ve got at least as many liabilities as assets and that you might not be able to meet those obligations based on the cash coming in,” Langdon says.

A business’s debt-to-equity ratio (how much of that business creditors own vs. how much the operator owns) is calculated by dividing current liabilities by current assets. Therefore, if a business has $200,000 in current assets and $37,500 in current liabilities the debt-to-equity ratio is 29 percent to 71 percent — a highly favorable spread, Langdon says.

“The better that ratio, the lower the risk for the owner and the bank,” he says. Having that information stated clearly on a balance sheet increases the chance a bank will extend credit. “Banks loan cash and expect to be repaid cash plus interest. When you’ve got a good debt-to-equity ratio, odds are you’ll be able to pay them back.” 

Why do I need a Balance Sheet? 

It’s the most immediate way to assess your pizzeria’s fiscal health now. 
It’s what bankers will ask for first — not your P&L — when you apply for credit. 
It lets you know how much cash you have, and how much you’re owed. 
It lets you know how much of your business you own, and how much creditors own. 
Confused and want to hire a bookkeeper or accountant? Check any prospective number cruncher with one or more tests (some are free, some come with a fee) available on the Internet. You also could test them by asking them to explain some accounting principles to you. It’ll provide insight into how well or poorly ? they’ll communicate with you in the future.

Steve Coomes is a former Pizza Today editor and a freelance writer living in Goshen, Kentucky.