Preface: A fisherman is certainly not ready to troll for big-game saltwater fish with a 20lb braided test line. But if you’ve got an 80lb braided test line, then you should be equipped to troll the saltwater seas for Marlins.
Surviving a Debt Euroclydon (Segment IV)
Managing a business with a high liability to assets ratio requires continuous cash flows to keep the financial pumps primed. Preparing appropriately for such changes in cash flows, for even short durations i.e., rain on a parade, can ease cash flows shock risks and strengthen balance sheets.
Preparing for a Debt Euroclydon can begin with two easy tools. Tool one is working on optimizing the analytical ratio of equity to total assets or total liabilities and equity. To calculate this ratio accurately requires precise balance sheet accounting and accurate month-end closing processes.
A business that has accurate financials with an equity to total assets ratio above 80% is prepared for a host of financial risks. To build a balance sheet of that strength requires either back-to-back years of grand performance earnings that need to be retained in the enterprise, or a strong capital base. A business with less than 50% equity to total assets is average in balance sheet strength, and with when measured with 20% or less equity to total assets is operating with maximum risk. The analytical ratio tool of equity to total assets can be likened to fishing with a braided fishing line. A fisherman is certainly not ready to troll for big-game saltwater fish with a 20lb line. They are advised to best fish easy for small native fish because the line will snap on the first big-game bite. But if you’ve got an 80lb test line, then you should be equipped to troll for some saltwater Marlins.
Here is how you can assess your businesses strength with the Equity to Total Assets or Total Liabilities + Equity ratio analytic.
Notice on the left side of the above analytic with the $5,000 of equity, there is a 3% equity ratio to total assets on a hypothetical $150,000 of total assets. Building equity can occur with two possibilities. 1) earn more net income and retain it in the business, 2) contribute capital to the company in the form of investments. The 87% ratio on the right side of the above analytic is the equivalent of 80lb braided fishing line you’re ready to plan to fish for Marlins. In addition to building equity, a keen financial analyst would also suggest to scale back the balance sheet reducing both assets and liabilities with say a sale of assets including lower inventory, or collections on receivables with a corresponding payment of balance sheet liabilities with the cash.
Watching trends in this ratio will provide confidence in your financial management decisions. The ratio is rarely static and should be closely monitored for the range on trend developments. A 100% is unrealistic because there are usually some accounts payable, accrued expenses, and say credit card expenses month-to-month.
If you measure this ratio analytic on your business and it is below 20%, don’t expect to win the current weeks saltwater fishing derby for the big game. Begin to accumulate and build the ratio on smaller fry until you have the capital to troll for larger big-game saltwater fish in the future, i.e., additional employees and general overhead.
To be continued…..