Running a business has many challenges, including riding cyclical economic cycles. These macroeconomic factors are out of your control, but they can profoundly impact your business.
Good economic times are great for business owners. People are willing to spend more, so your products and services are in demand, banks and investors are eager to lend more, and more opportunities are often available to grow and expand your business.
Conversely, an economic downturn can be difficult for business owners. During recessionary or slow economic seasons, your business may deal with a lack of demand, an inability to borrow money, or higher interest rates when you do borrow money.
A strong balance sheet will help you weather any economic downturn and can even help you take advantage of opportunities when they arise.
Why businesses need healthy balance sheets
Your business balance sheet can give you great insight into the financial health of your business. It is a list of the business’s assets, liabilities and equity. A balance sheet, also known as a statement of financial position, represents the financial value of a company at a point in time.
The balance sheet is a tool to help you make decisions for your company. It will tell you if your business is retaining profits and whether it is solvent, and this financial statement will help you analyze the quality of your assets and liabilities.
Lenders rely on it when deciding whether to lend to potential borrowers. Investors depend on it to decide whether or not to invest in the company.
A strong balance sheet means that your business:
- has enough cash to pay its upcoming liabilities
- has a healthy mix of debt and equity financing
- has productive, income-generating assets
- can continue operating without concern.
A business with a strong balance sheet can weather economic downturns. When the economy improves, it is ready to take on opportunities as soon as they arise.
Six areas to focus on for a strong balance sheet
If you’re looking to improve the financial health of your business, here are six key areas to focus on the balance sheet so that you are ready for uncertain economic times.
Debt to Equity Ratio
One of the most important things you can do to improve your balance sheet is to focus on your debt-to-equity ratio. The debt you owe compared to your equity is a critical metric that financial institutions use to determine the health of a business: the lower your debt-to-equity ratio, the better.
You can either pay down debt or increase equity to improve this ratio. One way to increase equity is to invest in long-term assets such as real estate or machinery. Another way to do this is through share repurchases or increasing retained earnings.
Cash and Receivables
No matter the economic season, cash is always king. Your business can endure rough economic times when you have a handle on your cash flow without borrowing money at higher interest rates.
If you experience lower demand and revenues slow down, it is crucial to plan how much cash you need in the bank to pay for ongoing expenses.
Businesses often find it harder to collect receivables during recessions. Your customers, whether they’re consumers or other companies, will also be affected by tough economic times. The older your receivables, the harder it can be to collect them.
To improve this number, you can offer early payment discounts to customers to incentivize them to pay upfront. You can also invest in services to collect receivables faster such as invoice factoring.
Inventory
If you’re a business that sells physical goods, managing inventory is a critical area of your business. These include the raw materials, finished goods, and work-in-process that a company has on hand.
If you have too much inventory, offering discounts for slow-moving products or bulk orders can also help you improve your financial situation.
You might also want to review inventory management plans. If you are looking to purchase new inventory for upcoming months, take into account macroeconomic events so that you don’t hold onto too much stock at once.
Other Assets
Other fixed assets are a company’s long-term assets, such as real estate, machinery, and equipment.
You can invest in leased assets or sale-leaseback arrangements to improve your balance sheet position. You might consider selling some of your fixed assets if they are no longer needed to generate the cash you might need.
Reduce Short-Term Debt
Your short-term and renewing debt can be a source of uncertainty during economic downturns. Debt due within the next 12 months can cause instability in your business.
As interest rates increase, you might be stuck with higher borrowing costs. Or lenders may be more particular and not extend credit as freely as they used to, making it harder to renew loans.
If you have debt that is renewing in the next year, it is essential to create a plan. Communicating with your lenders can also help you gauge what credit terms they may offer and what you can do to keep your borrowing costs down.
Payables
Another area to pay attention to is your payables or the money you owe suppliers.
You can negotiate with suppliers to ensure you get the best rates for the things you need to run your business. Maybe ask if they can extend credit on favourable terms when you’re short on cash to improve your cash position. You can also invest in tools that help you manage payables, such as accounts payable automation.
How to strengthen your Balance Sheet?
By focusing on the health of your balance sheet, you can be ready to take on rough economic times.
Your business can weather economic downturns if you have a strong balance sheet. And when the economy improves, it will be ready to take on opportunities as soon as they arise.
Focusing on these five areas can improve your balance sheet and weather the storm during an economic downturn.
Contact McCay Duff LLP in Ottawa for Experienced Accounting Advice
If you need personalized advice on strengthening your balance sheet, a skilled accounting professional can help you find opportunities to bolster your business even in times of uncertainty. At McCay Duff LLP, our financial and business experts can provide you with the support and advice you need, tailored for your business. To learn more about how McCay Duff LLP can provide you with the best accounting expertise, contact us online or by telephone at 613-236-2367 or toll-free at 1-800-267-6551.
