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The 2019 year-end Duke University/CFO Global Business Outlook survey produced some impressive results. Close to half of CFOs predict that an economic recession will hit by the end of 2020, and approximately 75% expect a slowdown by mid-2021. These predictions have many businesses planning for the next economic downturn. Have you started? These four steps will help your company strengthen its balance sheet against a rough financial future.
- What is most important to your company? Your company’s balance sheet is a snapshot in time of it’s financial strength. The balance sheet showcases both assets and liabilities and can help determine the financial focus of your business. Each company needs to determine which line items are vital to its success. Inventory is always a priority for retailers, while accounts receivable is indispensable for professional service firms. Many CFO’s utilize a “common-sized” balance sheet to determine financial information is most relevant. This type of report represents each account or monetary category as a percentage of total assets. Items can be ranked, with the highest percentages indicating the line items that warrant the most attention.
- Have you analyzed your ratios? Ratios are used to compare line items on your company’s financial statements. Often, they can be divided into four categories: 1) profitability, 2) solvency, 3) asset management, and 4) leverage. The profitability ratios focus on the business’ income, while the other categories work to assess items on the balance sheet. For example, the current ratio is determined by dividing the current assets by current liabilities. This ratio can be used to assess whether your company has enough existing assets to meet current obligations over the short run. Likewise, the days-in-receivables ratio, which divides accounts receivable by annual sales and is multiplied by 365 days. This ratio is an asset management ratio that gauges how efficiently the business is collecting receivables. And the debt-to-equity ratio which has interest-bearing debt divided by equity analyzes your company’s use of debt vs. equity to finance growth.
- Have you set your goals? The common-sized balance sheet and ratios can guide your company in the creation of “goals” for each essential line item. Determining the right goal depends on both the nature of your business as well as industry benchmarks. Your company goals for the following year may include: increase cash as a percentage of total assets from 5% to 15%, improve the current ratio from 1.1 to 1.2, decrease the days-in-receivable ratio from 40 to 35 days, and lower the debt-to-equity ratios from 5.6 to 4.
- Can you forecast the impact of your goals? Once goals are set, it is critical to devise a plan to achieve them. One example might include cutting fixed costs and postponing plans to buy equipment to build up your cash reserves. Furthermore, stockpiling cash and improving your collections — might strengthen and increase your current ratio. Part of your company’s plan should include forecasting how the changes will affect your company by filtering your goals through the financial statements. This feedback can help determine how realistic your goals are. For example, if your business decides to build up cash reserves, they may be unable to pay down debt simultaneously. Companies can generate only a limited amount of incremental cash in a year and early forecasting can help pinpoint the shortcomings of your plans.
We can help
Markets are cyclical. We all know that it’s only a matter of time before another downturn happens. JLK Rosenberger can help you take steps to position your organization to weather the next storm — whenever it arrives. For additional information, call us at 949-860-9902 or click here to contact us. We look forward to speaking with you soon.