We’ve often said that a focus on the balance sheet is a waste of time because of its shortcomings as a useful document. Yet lenders still rely on the information in it to make decisions.
A practical example of just what’s wrong with it came up just a week or so ago. A stock exchange listed company produced its interim financials to 31 December 2017 and shocked some analysts by reporting a negative cash flow from operations of US$220,000 which, after tax, interest and dividends grew to around US$4m.
The negative cash flow resulted in a drop in its bank balance from around US$8m at the end of June 2017 to around US$3m at 31 December.
Their bankers would have been taken aback by those figures and would have considered a review of facilities. The negative cash flow may have even triggered some covenants attached to their borrowings. Bad news indeed!
However, there was a simple explanation. Because 31 December fell on a Sunday and the following day was a holiday, the collections from accounts receivable (trade debtors) which would normally have been in the bank before month-end were delayed until the start of January. Had those funds been banked (as they would have been if 31 December fell on any other working day), the cash flow from operations for the 6 months to 31 December would have been a positive US$3.5m and the bank balance would have been US$6.5m.
Remember that these figures in the cash flow statement were taken from the balance sheet so it was the fact that the balance sheet reflects the position on only one day of the year that caused all the trouble.
Two things become evident from this story; one, don’t believe what you see in a balance sheet (or a cash flow statement) and two, don’t assume any figures to be accurate without first checking with management of the business.