In my last blog post we discussed why you should read and analyze your Balance Sheet. Now we’ll discuss how to use it in your business.

Each month you should compare your current Balance Sheet to the prior month and to the prior year the same month. How does the current Balance Sheet compare? Hopefully you have less debt this month than you did last month or last year. Did you add new assets? If so, how have those assets contributed to your revenue (you’ll have to analyze the Income Statement to answer this question)?

So what information does the Balance Sheet provide? Here are a few of my favorite Balance Sheet ratios with a description of the knowledge gained from the results:

1. Current Ratio. Determined by taking your current assets divided by current liabilities. You want a ratio of at least 1:1 or better. This ratio measures your ability to convert your current (short term) assets into cash to pay your current (short term) debt. Generally, a ratio of 1:1 isn’t going to give you enough cash to pay your debts so you want to strive for a 2:1 or better.

2. Receivables Turnover ratio. Compare your net credit sales to your accounts receivables by taking Net Credit Sales divided by Average Net Receivables. The result will give you the number of times per year you collect your accounts receivables. For example, if the result of the formula is 6 then you are collecting your receivables about once every 60 days.

3. Average Collection Period. Convert your Receivables Turnover ratio into days outstanding by taking 365 and dividing by the Receivables Turnover ratio result. Assume your Receivables Turnover was 12; we would then get 30.4 days your receivables are outstanding (ratio: 365/12).

4. Debt to Total Assets ratio. If you needed to convert your assets into cash to pay your long-term debts, would you have enough to cover your outstanding balances? The Debt to Assets ratio will tell you. To determine the proportion of debts to assets take your Total Liabilities divided by Total Assets.

Perform an analysis on your Balance Sheet for the current month. Then do the same for the prior month and the same month the prior year. What do the trends look like? What information have you gained from this analysis?