The Balance Sheet: A Marketing Agency Snapshot
Let's talk about balance sheets. Most agencies leaders rarely reference them; but despite this, they are one of the most important documents to assess the financial health of your business. A balance sheet is a snapshot of what your business owns (assets), what it owes (liabilities), and the difference between the two at a specific point in time. The term “equity” describes the difference between what your business owns and what it owes. In accounting terms, equity is always assets minus liabilities.
Think of the balance sheet as a house (asset). You have a mortgage you pay to the bank (liability), and equity is how much of the home you own. In this guide, I’ll detail how you can properly interpret the balance sheet: one of the most powerful tools at your disposal.
READING A BALANCE SHEET
Balance sheets are a little tougher to read than income statements because they don't intuitively follow your budgeting process. Any budgets you've put together in the past include revenue, expenses, and other line items—it essentially mirrors the look and feel of an income statement. On the other hand, the information included on a balance sheet rarely figures into your budgeting process. This turns many folks away, and causes them to rarely reference the balance sheet for financial health insights.
In the following sections, I will walk you through an example of what your balance sheet might look like. I'll explain what each section means and help you read this critical document, thus unlocking a better understanding of your agency's health. Feel free to follow along using a copy of your own balance sheet.
»Click here to follow along using a sample balance sheet
This is a link to a Google Sheet that you can take, tweak, and make your own. Click File > Make A Copy to save it for yourself.
ASSETS
Put simply, assets are what your business owns. Current assets are anything you own that can be turned into cash in less than a year. Long-term assets include physical assets that have a useful life of more than a year—usually anything that is depreciated.
Your current assets may include the following categories:
Cash and Cash Equivalents. Another name for this category is “liquid assets.” This is the money in your checking and savings accounts. It also includes any certificates of deposit and publicly-traded stocks. I've always liked the idea of agencies creating an investment fund made up entirely of their clients. Of course, this only works if your clients are publicly-traded firms. This always seemed like a strong message to put on your website about the growth of your client portfolio.
Accounts Receivable. This is the amount customers owe your business. This is considered an asset because most of these commitments (sans bad clients) will convert to cash. Accounts receivable is one of the line items I advise clients to watch closely to determine how efficient they are at collecting money owed to their business.
Less Allowance for Doubtful Accounts. This is an estimate your accountant will make, based on experience, of money owed by clients who you doubt will pay their bills. For instance, your accountant might estimate based on historical collection efforts that you only collect 95% of the dollars owed to you. In this example, subtracting a 5% allowance provides a more accurate reflection of the value of your accounts receivable. Since this is an estimate, there is room for subjectivity.
Prepaid Expenses. Prepaid rent is one example of a prepaid expense. Say your rent was $2,000/month, and you decided to pay for the entire year in January. You wouldn't book the entire $24,000 as an expense in January; you need to spread out the cost over 12 months, since you'll be using it for that amount of time. In January, you would book $2,000 on the income statement as a rent expense—then, you would keep track of the other $22,000 on your balance sheet as a prepaid expense. Since you have the rights to the space for a year, this is considered an asset, and the balance sheet is where we keep track of assets.
Work in Progress (WIP). This is work you've done, but have not billed to your client. This is similar to inventory for product-based firms: you have an asset, but you simply haven't invoiced a client for it yet. Many agencies don't do a good job of tracking WIP, so chances are, your accountant may not have this as a line item on your balance sheet. A good sign that your agency does not do a good job of tracking WIP is when you find yourself writing off client work.
Your long-term assets may include the following categories:
Property, Plant, and Equipment (PPE). This line on the balance sheet includes all physical assets your business owns. You will include computer and equipment in this line. PPE shows up as a line item when you own the building and/or land your business operates from. Many of you won't have this line item on your balance sheet, so I recommend simply having computers and equipment as a separate line item.
Computers / Equipment. In this line, you will include the purchase price for all your computers and equipment.
Less: Accumulated Depreciation. By accounting depreciation, you can allocate the investment over the time the equipment is used to generate revenue and profit. The depreciation charge ensures that your income statement accurately reflects the true cost of delivering agency services. To calculate accumulated depreciation, your accountant will simply add up all the charges for depreciation they have taken since an asset was purchased.
LIABILITIES
Liabilities are the financial obligations you owe to other businesses. Your liabilities are divided into two main categories: (1) Current liabilities are those that have to be paid off in less than a year, and (2) Long-term liabilities are those that extend past one year.
Your current liabilities may include the following categories:
Accounts Payable. Shows the amount your agency owes its vendors on the date of the balance sheet.
Line of Credit. Lines of credit are usually secured by your accounts receivable. In the past, some of you may have factored an invoice to access cash sooner than your client typically pays out. There are pros and cons to invoice factoring, but the important point is average factoring fees—which typically range between 1% and 5% of your invoice.
Taxes Payable. Indicates the amount your business expects to pay in income taxes within 12 months.
Current Portion of Long-Term Debt. Let’s say your company owes $200K to a bank on a long-term loan, and $20K of it is due this year. That $20K is the amount that shows up in the current liabilities section of the balance sheet. The other $180K will show up under long-term liabilities.
Most of your long-term liabilities will be loans. In the example above, you would owe $180K on a Notes Payable under long-term liabilities.
OWNER’S EQUITY
Owner’s equity is what's left after we subtract liabilities from assets. Equity is essentially the net worth of your business. It includes the capital provided by agency owners, and the profits retained by your business over time.
Your owner’s equity may include the following categories:
Owner’s Initial Equity. This is the amount you and any other owners have invested into the business. For example, if you started the agency with $1,000, then that would be the amount listed here.
Owner’s Draw. The amount of money you take out for personal use is the owner’s draw. It's a way to pay yourself instead of taking a salary.
Net Income Year to Date. This number comes from your income statement and is sometimes referred to as “retained earnings.”
ASSESSING YOUR FINANCIAL HEALTH
The balance sheet answers a lot of questions about the financial health of your business. Although it is tougher to read than an income statement, it provides valuable insight into how you've been running your business over time. As you review balance sheets from different periods, you want to pay attention to any notable trends—for instance, an increasing cash cushion and increasing equity.
Your balance sheet provides answers to many of the questions you want answered.
How much cash do we have on hand, and is it enough to cover at least three months of overhead?
How much do clients owe us?
Can we afford to pay our vendors?
How much have clients paid us in advance for work not yet performed?
How much do we owe in taxes?
Has owner’s equity grown over time? (By comparing balance sheets from different periods, you can see whether owner’s equity has been moving in the right direction.)
As usual, consider my thinking as a framework for your own decisions—not prescriptive advice. After all, your own situation is unique.
If you're interested in learning how you and your team can better interpret the data in your financial statements, please reach out about my profitability workshop. Initially designed for breakout sessions at conferences, I have customized this service into half-day sessions on-site with creative agencies like yours. I will use your financial statements to give you a better read on your financial health, and specific steps to improve moving forward. I look forward to seeing you there!