Signs of Cash Flow Trouble Found on the Balance Sheet
Your business is growing. With robust demand from new and existing customers, you see your revenue increasing in the years ahead. That's the good news.
The tricky part is, you’re not certain your new revenue will materialize in time to meet your increased payroll obligations and equipment costs.
According to Josh Ronald, this situation is all too common. Ronald is a Partner at Stawowski McGill & Partners, a financial-based business consulting firm based in Calgary, Alberta. In his experience, many growing companies eventually run into a cash crunch, with ample receivables but not enough cash in the bank to pay their bills.
One place to look for the signs of a future cash crisis is a company’s balance sheet. In Ronald’s view, growth-minded companies can use and manage the information on their balance sheet to avoid a cash crunch as they expand the business.
Strike a Balance Between Strong Working Capital and Manageable Debt
Is paying for assets out of cash flow more prudent than borrowing? It may seem so intuitively, but in Ronald’s experience, paying cash for hard assets can actually be riskier than getting a loan. Even when they borrow, many companies don’t obtain the right terms.
"Suppose they want to buy an asset with a working life of six to seven years,” says Ronald. “Their lender may want them to pay for it over three years, and that can put a strain on working capital. If you find a lender who understands what you do, it would make a lot more sense to finance that piece of equipment over five years."
Ronald puts his clients’ financial data through a battery of analysis, using different ratios to determine where they’re at and how this is changing over time. He believes that two ratios should be monitored by all companies, especially those in growth mode.
Ronald recommends that oilfield service companies maintain a debt-to-equity ratio of 1.0-1.5 to 1 and a working capital ratio of 1.5-2 to 1.
Part two of this month’s VistaVu blog post covers month-end tactics to understand and accelerate your cash flow. Stay tuned!
