5 Ways to Get Real Profits Out of Your Balance Sheet

Gene Siciliano

Do you want to have more financial control of your company? Of course you do, or you wouldn’t be reading my posts. But let’s be clear: this is not an attempt to make you into your own controller. We have people who do that for you. Rather, whether your role is CEO, President, owner/operator, senior executive or advisor, if you have some responsibility for guiding a profit-making enterprise, this is for you.

In fact, this is about the opportunity to assess your company’s financial health as you set goals for the balance of this year and next. The premise: The health of your company today is not determined by last year’s profit or last year’s sales. It’s determined by how well you are positioned to make your assets produce a profit for you today and tomorrow. And that is best determined by looking at those assets themselves, and the related liabilities, to try to predict the kinds of challenges you’ll face as the economy recovers oh, so slowly. In other words, let’s look at your Balance Sheet.

Your company’s balance sheet is that financial report frequently overlooked as CEOs scan ahead to see the bottom line number on the income statement. It’s the report many CEOs only look at when their banker asks questions about it. But there is a wealth of information in that one-pager, a host of opportunities to improve your business, and your future net worth, by reviewing and fixing some of the anomalies that may show up on your balance sheet – anomalies that sooner or later will show up on your income statement and in your bank account. Here is Tip #1, the first of five tips I’ve selected to help you understand the power of this strategy:

Quick Ratio: Your company’s current assets minus inventories divided by current liabilities. Does your Quick Ratio indicate you may have loaned too much money to slow paying customers? If you don’t have $1.50 to $2.00 in current assets for every $1.00 of current liabilities, you may be doing more scrambling for cash than you need to. Speeding up collections is often the simplest and easiest way to raise your cash balance and free up cash for reinvesting in the business. Ask us for our 5 tips for increasing collections without mutually painful arm-twisting or damaging the customer relationship.

Tip #2:
The relationship between Accounts Receivable and Accounts Payable: There should be a substantial difference between accounts receivable and accounts payable, at least in part because your A/R contains a profit margin while your A/P is pure cost. That’s an admitted oversimplification since your labor costs are typically also in A/R but not A/P, but it’s a very quick way to see if your working capital is out of balance. I think your A/R should be at least double your A/P. Yet if you are paying your creditors promptly but not collecting from your customers with equal promptness, the ratio may look great but in fact you’ve created an imbalance that can starve the business. Consider also stretching your payments to suppliers a bit to narrow the gap. Ask us about the concept of “Natural Payment Terms” if you’re not sure how to do this.

Tip #3:
Inventory Turnover: Average Annual Cost of Goods Sold divided by Average Inventory. A major element of working capital for many companies is inventory – the stuff you make or buy, or both, to resell to your customers. Does the amount invested in your inventory– even after you write off the slow moving stuff you should have written off years ago – take up too much of your balance sheet? How can you tell? Look at a ratio called Inventory Turnover, i.e., how many times a year does your inventory completely replaces itself. Better yet, do that for each individual high value or low shelf life product you sell. Then compare turnover with the average shelf life of that product, e.g., if your inventory turns over twice a year and the product is replaced with a new version every two years, you are letting ¼ of the product life sit on your shelf tying up cash. Ask us about an inventory control system that will prevent a situation like this from happening.

Tip #4:
Your equipment: fixed assets, machinery, vehicles, computers, etc. A quick look at the cost of all that equipment compared to the accumulated depreciation, also on your balance sheet, will show you its “Net Book Value ("NBV").” In other words, how much is left to depreciate before those assets have been written off the books and in theory used up. If the NBV is low in relation to the original cost of the equipment, you can be pretty sure that either your maintenance costs will go up or you’ll have to spend money to put new equipment in place – or both. Don’t disregard this idea just because you use aggressive write-off methods to save taxes. The concept is still valid regardless of your tax reporting practices. So here are two questions for you: #1 - Does it make sense to buy new equipment that will increase your productivity by 10% or more if you can borrow the money for 4 or 5% or less? It does if you have the cash to service the debt. #2 - What is the Return on Investment (“ROI”) of the cash you’ll tie up in the process? If figuring the ROI of all that gives you a headache, ask us to help. We do this all day long.

Tip #5:
Look at your loans and credit lines. Whether from a bank or a finance company, equipment lender or whomever, if those loans have been on your books for more than 2-3 years and their interest rates have not come down significantly, you are overdue to refinance them to get your cost down to market rates. Of course if your balance sheet isn’t in shape that might be a problem. If your bank won’t budge, ask us to introduce you to a more flexible banker. We know some, and they’re getting increasingly competitive as the economy recovers. And keep in mind: a bank’s cash reserves earn nothing if they’re not loaned out.

Another clue: a big bank lending to a small company. You don’t have much bargaining power because your business won’t move the needle for them. That also means your relationship officer doesn’t gain much by going to bat for you. So if they won’t budge, you need to go shopping for a new bank. If you don’t talk banker language, we do that very well. One big bank officer told us we gave him the best loan renewal request package he’d ever seen, and we got the loan renewed despite a loss year for the client, because we helped the banker see the improvement possibilities.

Bonus Tip:
Remember, the ultimate financial purpose of your enterprise is to convert cash to assets and to put those assets to work creating more cash than you invested in the first place. Not profits, cash. Profits are the promise of cash to come, but cash is the real profit. And if you don’t routinely analyze your company’s statements of cash flow – say what? – that balance sheet is the best gauge of cash productivity you’ve got.

If this is more number stuff than you want to wrap your head around, but you can see the possibilities, perhaps we should have an exploratory conversation. We wish you strong growth this year with lots of (cash) profits in the bank by year’s end.

Gene Siciliano is author of Finance for Non-Financial Managers.
Copyright 2013, author retains ownership. All Rights Reserved.

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