Could Your Business Withstand A Double Dip Recession?
Political and economic gurus are all struggling to answer one of today’s most pressing questions, “Are we in for another recession – the dreaded double dip?” In my opinion, only time will tell. But, that is not really the question or issue that you, as a small business owner, should be focused on. The question becomes, “Can your business survive another recession or economic slowdown?” A quick and simple way to answer this question is via a single financial ratio calculation called the Safety Ratio. The safety ratio measures a firm’s debt-to-equity or its ability to cover its debts immediately should the need arise. Debt in this case does not just mean items like bank loans or credit card debt but all liabilities of the business. The reason this ratio is important is that when economies decline and consumer (business and individual) pull back their spending, businesses face diminishing revenues; revenue used to pay their debts and other obligations. If a business cannot pay its obligations like suppliers, vendors, rents, payroll, utilities, etc then the business becomes insolvent and HAS to shut it doors. To measure your firm’s safety ratio, simply take your Total Liabilities and divide them by your total Equity (both balance sheet items). As mentioned, total liabilities can include any outside bank or credit card debt (short-term and long term) as well as accounts payable to suppliers and vendors, payroll liabilities, tax liabilities or any and all accrued expenses. Equity usually comes in two forms – cash injections from the owner, partners or outside equity investors or from holding retained earnings (net profits) in the business. As a general rule of thumb, this ratio usually ranges between 1.50 and 2.00. But, the higher the ratio, the more risk to the business from a recession or slowdown. If your ratio is over 3.00, it means that your business has three times the debt or obligations then it does in equity to pay those obligations and could mean that your business is in trouble now regardless of the state of the economy. Should you find that your safety ratio is higher then it should be or even if you just want to reduce your business’s reliance on debt and better position it should another slowdown materialize, here are four ways to improve your debt-to-equity ratio: 1) Use any and all cash reserves in the business to pay down your liabilities; particularly those liabilities not directly matched to assets that can be quickly converted into cash. Examples: You used a business loan to finance a piece of equipment and that equipment currently has a fair market saleable value of $10,000. Then, make sure that the balance on that loan is $10,000 or less. Or, you have $10,000 in accounts payables to your suppliers but you also have accounts receivables that more then offset those payables. Keep in mind that in a recession some of your accounts receivables will become uncollectable. Thus, make sure you have at least 1.25 times the amount in receivables to your payables – in this case you should have, at least, $12,500 in accounts receivables to cover your $10,000 in accounts payables. If not, pay down your accounts payables or increase your accounts receivables from solid customers. 2) Pay down all outside bank or similar debt, come current on all tax and payroll liabilities or at the least earmark cash (by moving it to a separate account that you will not touch) for those liabilities and sell off any unused or under used equipment and use those funds to reduce the debt tied to those assets. 3) Increase equity in the business by either putting in more equity yourself or finding outside partners or investors who will inject cash into the business. 4) Increase business profits by rising prices, if you can, sell more or push better margin items or reduce operating or overhead expenses that are not key to your business. The goal here is that the more profits your business makes, the more in retain earnings the business can hold in the company to handle any uncertain future event. Now, it is not certain that our economy will double dip in the near future. Nor is it certain that should we enter another recession your business will falter. However, understanding the potential risks your firm could face and knowing how to safely position your company to face any uncertainty can almost guarantee that should another recession materialize your small business will be one of the ones that survives to fight another day. To calculate your Debt-to-Equity ratio, use this simple financial ratio calculator with explanation and advice. About Author Joseph Lizio holds a MBA in Finance and Entrepreneurship and has a strong commercial lending background. In his current venture, Mr. Lizio is the founder of - Business Money Today - , a site designed to help business owners find and obtain capital to grow their businesses. Disclaimer: Article submitters are solely responsible for the content of their articles. ArtiLib can't be held liable for the contents of the articles. Report Abuse | Browse By Category |
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