The worst time to ask a bank for cash is, ironically, when you need it most. The best way to solve this cash flow challenge is by building a fortress balance sheet. A fortress balance sheet is one that can withstand shocks, particularly those that may come out of the woodwork.
The Fortress Balance Sheet Concept
Like a frontier outpost or an ancient walled city, businesses that prepare for a siege or attack can often hold out until the crisis passes or the cavalry arrives. It means that your business is using banking analytics to develop a balance sheet your banker will love. Here are three concepts to use when developing your fortress balance sheet:
- Debt-to-equity ratio. The calculation is total liabilities divided by total equity. A fortress balance sheet has much more equity than debt. Your first goal is to get this ratio under 1.0. When that happens, you have more equity than debt.
- Debt service coverage. Fortress balance sheets have enough cash to pay your debt obligations and then some. Look at your earnings, then add back interest expense and non-cash items like depreciation. Next, take this number and divide it by your debt service payments. If this ratio is under one, you’re in trouble. If this ratio is over two, you’re in the blue!
- Liquidity is key. Everything starts and ends with cash. A balance sheet heavy in items like unused equipment is tough to convert to cash. A fortress goal is to have enough in current assets to pay short-term liabilities.
Building Your Fortress
Here are some suggestions to keep you on a path toward building your fortress balance sheet:
- Control inventory and receivables. If properly managed, you won’t need to add debt to help pay for other things.
- Pretend you’re a bank. Are your debt service ratios and debt-to-equity ratios improving? If not, consider lowering shareholder distributions to maintain a high equity balance. Lower the use of your line of credit and cut costs wherever possible.
- Get rid of non-performing assets. It may mean consolidating locations, selling obsolete inventory, or getting rid of old equipment. Continually look at ways to convert these assets back into cash.
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