Squeeze the Balance Sheet to Improve Cash Flow
Everyone knows the value of a sponge: it absorbs water. Well, your company's balance sheet is just like a sponge, except that it soaks up cash, rather than water. This is not necessarily a good financial deal. As a sponge nears its capacity to absorb additional water it becomes increasingly less efficient. The same thing occurs with your balance sheet and the phenomenon has two basic causes:
Increasing sales (or growth), creates a need for additional money to finance an increased level of assets. The main source for most companies for this is from creditors, in other words, debt. Risk (in the form of increased debt) increases accordingly, and increasing interest expense may even put downward pressure on profits.
Furthermore, growth in sales is often accompanied by a decrease in the efficiency of the operation. This inefficiency really surfaces on the balance sheet as proportionally more assets are required to support new sales levels. In other words, the rate of asset growth increases faster than sales, you make the same percentage of profit, but you make it less efficiently.
So, what do you do? The clear message in a growth situation is straightforward - manage better!
Listed below are a few of the ways that can be done:
* Manage current assets (inventory, accounts receivable) more efficiently
* Restructure debt (long-term, not short-term)
* Make more profit
* Sell existing unproductive assets
* Curtail expansion
* Lease fixed assets
* Implement sale-leaseback of existing fixed assets
* Accept more risk (i.e. more debt)
* Grow organically
* Get new equity (a passive investor, or active partner)
By earning the same level of profits more efficiently, sufficient cash is squeezed out the balance sheet to significantly reduce the borrowing requirements.
Consequently, the concept of 'financial gap' can be applied two ways. First, it's effective as a tool to estimate borrowing needs in a growth situation, at an existing level of asset management efficiency. More importantly, it is an indispensable management planning tool for developing goals and standards of performance for efficient management.
Keep in mind, then, that there are three fundamental parameters in evaluating the growth capabilities of expanding companies:
1. How efficient is the company now?
2. The financial requirements of a particular company, that is, what new assets will be needed?
3. The owner's abilities as an 'asset manager', are they strong or weak?
Growth is reflected on the profit and loss statement as increases in sales and (hopefully) profits. The 'cost of growth' is generally reflected on the balance sheet in the form of increased debt to offset decreased efficiency.
These are controllable issues.
The sponge analogy? Well, efficiency translates to squeezing your balance sheet to free up the funds you need to grow; otherwise, you'll find it squeezing you!
For more information and more topics to assist in your business growth please visit us at: www.umacs-business-solutions.com
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