Building an Unsinkable Business (Part 4) Sound Financial Management Makes Your Business Unsinkable

Legend has it that in 1958 Dick Fisher, the founder of Boston Whaler (the company that designs and builds unsinkable pleasure watercraft) was reading an issue of Popular Mechanics when he came upon an article about polyurethane foam and fiberglass. Fisher’s epiphany was if you could fill the hollow core between an inner fiberglass liner (the inner hull) and an outer fiberglass surface (the outer hull) with polyurethane foam, the complete structure would float, and never fill with water even if the hull were breached and never sink.?

The rest – as they say – is history. ?Double-hulled, Boston Whaler designed boats have been the Volvos of the consumer boating world for decades.

To make your business unsinkable you need an unsinkable “foam” between the double hulls of your business - Liquidity (the outer hull and left side of your balance sheet) and Leverage (the inner hull and right side of your balance sheet). The inherently floatable foam filling the space between the hulls is Sound Financial Management.

Even Warren Buffet, the CEO of Berkshire Hathaway, arguably the most successful and consistently wealthiest person in the world, insists that his firm maintain a minimum of $10 billion in Liquidity. Why would he do that if it weren’t crucial?

Liquidity is the lifeblood of any business. It provides a business with the flexibility and confidence that should uncertainty in the economy create headwinds, the business will possess the cash and near-cash reserves to continue operations uninterrupted.

It is not uncommon for economic uncertainty to create volatility in financial markets. That volatility can negatively impact industry segments, consumer sentiment, and the valued relationships between customers and suppliers. Economic uncertainty triggers concern about the prospects for economic growth. Pundits will begin to describe retreating investor behavior as a “flight-to-safety”. The point is, when times are challenging, or leading indicators appear to signal the potential for an economic contraction, individuals and businesses take measures to protect against the consequences.

What control does the business owner really have?

Business owners can control the degree to which their balance sheet exhibits the resilience necessary to endure challenging economic times. Businesses gain competitive advantage vis-à-vis their competitors when their balance sheet is more resilient than their competitors’ balance sheets. A resilient balance sheet reveals both high Liquidity reserves and manageable levels of debt in relationship to equity, or Leverage.

To build liquidity and reduce leverage, a business must retain a portion of the profits it generates. Simultaneously, the business must consider the time required to collect Receivables, proactively manage the cash requirements associated with vendor/supplier relationships, and tightly manage inventory turnover/levels.

In fact, routinely observing trends in key financial management ratios such as Accounts Receivable Days, Accounts Payable Days, and Inventory Days constitutes a set of simple habits you can develop to gauge the health of your business. More importantly, managers can use this information to consider what might happen if the trends improve or deteriorate.

As an example, if a firm’s Accounts Receivable Days were 45 days last month, and 43 days the month before -- what happened? What caused the 2-day extension? Was it a one-time event? A special concession made to a new or larger customer to extend the terms? More importantly, if this trend persists how will it impact liquidity reserves? How about Inventory Days – have they grown? Why did they grow? Has there been a policy shift to purchase larger quantities of materials or products as a risk mitigation measure in response to uncertain supply chain dynamics?

Owners and CEOs empower their management teams when they begin to routinely review key indices and ratios - and use those revelations to ask questions and seek understanding.

Starting Simple

Beginning some basic financial review disciplines is not difficult.

In commercial banking, it is common to find debt-underwriting frameworks that focus on six (6) key financial ratios:

-?????????% sales growth year over year,

-?????????cost of sales as a % of sales,

-?????????operating expenses as a % of sales

-?????????Accounts Receivable Days

-?????????Accounts Payable Days, and

-?????????Inventory Days.

These are easy ratios to calculate, and while there may exist other key performance ratios in a business unique to its industry, the listed ratios provide a solid foundation for beginning financial management disciplines immediately. ?A firm’s accounting team and banker are the owner’s best friends in this regard. Do not hesitate to learn how the ratios are calculated.

Calculating the ratios is the easy part.

Developing the discipline and cadence of routinely reviewing financial ratios is where the value lies – and is therefore, the biggest challenge.

It is easy to go for a run today. But developing the habit of routinely going for runs, has a much longer and significant impact on health and overall well-being. Routinely reviewing financial ratios demonstrates a longer-term commitment to the financial health of a business.

Start Now

By now, most businesses will have completed their 2021 financial statements. The information needed ?for beginning the financial disciplines I am encouraging, ?Balance Sheets and Profit & Loss statements, is likely available.

Step 1: Compare the ratios at the end of the most recent fiscal year to the ratios at the end of the prior fiscal year – e.g. 2021 to 2020. What does that comparison reveal? What questions do the ratios raise? It has been said that good attorneys differentiate themselves by knowing the important questions to ask. Owners and CEOs can start by asking questions. Eventually, the important questions will reveal themselves.

To Executives in Charge

I am willing to bet that you possess some specific attributes and strengths that have been instrumental in your success. Perhaps, you are skilled at sales, managing people, engineering, design, communicating a vision, or some other valuable capability. You may not see yourself as skilled at finances. Do not let that deter you. Instead, use it to motivate you to challenge yourself, expand your skills, and engage more purposefully in the numbers side of your business. The ROI for your time will eclipse even your most ambitious guess.

A Final Thought

Malcom Gladwell – in his book Blink: The Power of Thinking Without Thinking – wrote about “the first two seconds” and how we make “blink-speed” assessments of things we see for the first time. Similarly, stakeholders and potential partners make snap judgments – or a “blink” assessment – of your business when they glance at your balance sheet.

It has been said that we get one shot at a first impression. No matter your audience, you want the first impression of your business to be favorable. First impressions are important and often become the kernel for how your business is perceived. While your reputation, culture, and brand are very important factors, your financial statements (in particular, your balance sheet) speak volumes to management’s stewardship of your business. A balance sheet which – at a glance – demonstrates sufficient liquidity and appropriate leverage, will imbue its reviewers (e.g. potential customers, suppliers, bonding agencies, bankers, insurance brokers, and employees) with confidence in your business. You desire this confidence, as confidence in you and your business is a primary catalyst for revenue growth.

Pay attention to your Balance Sheet, P&L, Liquidity and Leverage ratios and the predictive indices that drive them. The payback to you, and the positive impression it leaves with all your stakeholders, is invaluable.