After a recent Midwest speaking event, a crowd gathered around me for some questions and engagement. To encourage interaction, often I will be seated, not because my energy is low or that my age is showing. A professional facilitator encouraged me to do this because it is less intimidating and more on people's conversation level. One high-energy individual with a strong personality was blunt. He said, “Cut to the chase! With high inflation and possible lower prices, what are four actions or practices that we need to focus on financially?”
Preservation of liquidity
Working capital will be a manager’s and owner’s best financial friend in the coming years. While many reading this column have high land equity, the choke point on most operations is financial liquidity, particularly if the business is exhibiting negative margins. Working capital is current assets minus current liabilities. Maintain working capital greater than 25 percent of total expenses. The next ratio to focus on is if you are carrying debt, your working capital should exceed three times your total principal and interest payments on term debt. For example, if your term debt service payments are $100,000 annually, then you need to have $300,000 of working capital as backup and reserve. Remember, principal and interest payments on capital debt are a fixed overhead cost.
Interest rates are important when selecting a lender; however, in tough times a relationship lender that understands your industry, your business, and your personal goals is vital. Ideally, attempt to keep your term debt to EBITDA* under three to one. If it exceeds six to one, you better tap your brakes on adding term debt.
Operational efficiency will be key to success in coming years. Have a profit plan focusing on efficiency first, followed by growth. Then stash some of the profits in the form of working capital. Monitor your net margins and breakeven points to take advantage of profit windows. To measure operational efficiency, subtract depreciation and interest paid from your total expenses. Then, divide this number into total revenue. If this ratio is under 70 percent, you are doing extremely well.
Planning and monitoring
Develop enterprise budgets to monitor each area of your business. Cash flows are critical for the total business and, in some cases, for each enterprise. Quarterly and monthly monitoring will be critical to adjust marketing and purchase decisions. Marketing and risk management practices need three points of emphasis: price, cost, and interest rate strategies.
When I finished answering the question, his reaction was, “You need to write an article on this!” He said this as he walked away on his cell phone. Other onlookers just smiled and shook their heads because he is the local “alpha type” producer.
*EBITDA is an acronym for Earnings Before Interest, Taxes, Depreciation and Amortization
Source: David Kohl, which is solely responsible for the information provided and is wholly owned by the source. Informa Business Media and all its subsidiaries are not responsible for any of the content contained in this information asset.