An Affair with figures

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How to read a Balance Sheet?  There cannot be a simpler explanation than this…

This article is not for the men of numbers, the accountants, and the analysts.  It is for an entrepreneur who knows business, but finds it a maze to see a financial statement.  For a start-up it is a maze of numbers arranged in some assorted format.  We accountants further complicate the structure with ratios, and inferences.  This article is to understand a financial statement through ‘Shetty Angadi’.  ‘Angadi’ is a vernacular usage for the word ‘shop’.  The reader needs to visualise Shetty Angadi, and its surroundings to get the essence of the balance sheet.  Just imagine the shop, its settings and shelves.

Shetty owns a tiny shop like a village deli.  He sets up his shop with pride at the end of market road, closer to the river.  A cobbler Rahman is his neighbour, and a saloon of Peter stood next to him.  The village had a semi-tar road, and was sparsely populated.  It takes a lot of courage to be an entrepreneur in a tiny village.  Shetty opens his shop a couple of hours post sun rise, and closes it when the sun sets.  He had completed a decade of operations and was contended.

A visit to the shop would give a good idea of his operations.  It was a tiny room, and appeared to end before it starts.  Shetty sat in the middle and had a cash-till in front of him.  He guarded and garlanded it every day, and he worshipped the till.  This shows cash is the king.  On to the right of Shetty was a cupboard with four rows, and on to his left was another with four more rows.  Shetty sat amidst the shelves.  All his merchandise rested on the shelves.  To his rear was a wall adorned with pictures of Lord Krishna, Jesus and the crescent moon.

On the right side shelf there were four rows.  Shetty had earned his wealth from this tiny shop and saved hard.  Over the years, he had purchased a small plot, constructed a house. He also owned the shop.  The land documents, title deeds, the government stamped receipts were neatly stacked in separate files and kept on the top row of the right side shelf.  The next two rows had his merchandise to sell.  He had toffees, savouries, a few packets of toiletries like toothpaste, talcum powder, combs, shaving blades, notebooks and any saleable commodity.  He used to keep fresh stock in the front and the old and slow-moving stock at the rear.  In the lowest row were the cash box, the bank statements, and a short book, which had the account of people who purchased from him on credit.

Shetty’s right side had his property title deeds and its copies on the top shelf, the stuff he had to sell in the middle shelves and his cash, bank and moneys to be received on the bottom shelf.

The more you follow these cardinal rules of accounting, your business would work right.  The basic rules Shetty followed got him a house, a shop, deposits and reduced his loans and helped him set up a safe business.  Prudence in business is having assets, which yield income and cash to swell.

On the left side of his seat, he had another shelf.  This had four rows too.  The top most floor he had kept a box, which reminded him the moneys, his father gave him to start this store.  That was his capital.  He also kept his profits earned from business in this row.  This box had cash, which he would keep as a reserve.

The next rows had the loan papers from the local bank; he had mortgaged his house and shop to get a loan.  He had funded his house and shop out of his own earnings and the bank loans.  The loan agreements, the interest calculations were all in this shelf.  He did not understand the fancy spreadsheets.  The third shelf had bills he had to pay; this included the electricity bills and the vendor bills.  The last shelf in the bottom had space for keeping letters and notes for paying local village cess and taxes.  He regularly paid tax on his income, the shop taxes to the local authorities etc.  He kept those documents in the last shelf.

Now go back and read again, what are in the shelves.  Visualise the shop and keep a tab on the shelves.  This would help you read a balance sheet easily.

The right side shelf has all the assets, and the left side shelf has what he owes to others.  What he owes to others are liabilities.  Even the business owes back to him what he had invested, that is capital.

The top of the right side shelf had fixed assets like property, the next two shelves had his inventory.  In the inventory shelf, he had slow-moving items at the rear.  In the bottom shelf he had his cash, bank balances, receivables and deposits.  So the entire right shelf consisted of his assets.

The left shelf had on the top the money he had invested in the business, and his profits.  These were his capital and earnings.  The next shelf had bank loans, interest dues etc.  The third shelf had moneys he owed to others; let’s call them as payables or creditors. The lowest row had tax payable papers, let’s call them as provisions.  So the entire left shelf consisted of his liabilities.

Now go back and read again, what are in the shelves.  Visualise the shop and keep a tab on the shelves.  This would help you read a balance sheet easily.

Now observe the shelves carefully.  The right top row having assets should always be more than the loan shelf in the left side.  This is a healthy sign.  Similarly the inventory shelf should be more than the vendor payable shelf.  Attention has to be paid to the rear of the inventory shelf, it should be the lowest.  The higher the rear side of the inventory shelf, the worse the business would be doing.  Now see the lowest shelf in the right side, the cash is the king, and the receivable cover should never get old, it has to be collected as much as possible.

The more you follow these cardinal rules of accounting, your business would work right.  The basic rules Shetty followed got him a house, a shop, deposits and reduced his loans and helped him set up a safe business.  Prudence in business is having assets, which yield income and cash to swell.

Just see the lopsided business.  Many times the loan shelf would be very heavy and the asset shelf too would be very heavy.  The inventory would suffer, cash suffer, and as a result repayment of loan would suffer.  If the loan shelf would become heavier, the repayment becomes difficult.  The more difficult cash becomes, the loan would swell, and the asset row would be in trouble.

So the cardinal principal is a balancing act.  Let the loan shelf be lesser than asset shelf.  Let the cash shelf move from low right side bottom to left side top, which is owners’ capital.  Let the inventory rear side be as less as possible.  Let the vendors payable be optimal, so that people would supply to you at right price, and you can have higher profits.

Shetty Angadi is a classic example of a healthy life.  It is similar to a human body.  All the parts should be proportionate and balanced; if the tummy becomes huge, there is an issue in the body.  Similarly if any one shelf becomes too big, there would be an issue in the business.  Ensure all the rows in the cupboard balances.

Balance sheet is balancing your business.  It is simple system of storing items in the respective shelves and having an eye on them always.  Keep track of your numbers; your numbers will take care of your wealth.

The sun is setting, and Shetty Angadi would close now.

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