Capital Ratios: Safety Margins (6 of 6)
July 1st, 2010
Copyright © 2010 Integrated Profitability TM
As a reminder, Equity-Capital ratios that focus on a company’s safety margin are the main point of the Small Business Finance & Profitability Equity-Capital series:
● How large is your financial cushion?
● Are you well-capitalized?
Well-capitalized companies have flexibility that their less well-endowed competitors don’t:
● Funding for the business: more money can be poured into improving the business
There can be infrastructure investments to decrease costs and improve productivity. Research & Development (R&D) can be increased to develop better products and services. Process improvements can be made to increase customer satisfaction and loyalty. Marketing dollars can fine-tune new customer acquisition and new product development. Time and money can be spent on strategically thinking about, planning for, and taking action to maximize the company’s long-term, sustainable profitability.
● Weathering rough patches: money can be used to plug gaps in net-profit
As singer Lynn Anderson sang, “I never promised you a rose garden.” Business is never an unending string of profitable years. There are always a few potholes, and an occasional landmine, on the commercial highway, street, or back road. Equity-Capital allows companies to cover these rough spots without cannibalizing its operations.
● Rewarding investors: dollars can be returned to your investors
Healthy equity-capital allows companies to return some of their earnings to investors (either as dividends or as stock-share buybacks). Also, companies with solid equity accounts are better able to withstand downward pressure on their stock prices. Better investment returns to shareholders encourages a willingness among investors to purchase and hold a company’s stock. Access to the capital markets is an obvious advantage for a company.
Bottomline: in a rapidly changing global economy, strong equity-capital provides any company additional competitive advantages.
Capital, debt or equity, can’t replace solid management, good product/service lines, and efficient operations. Better-than-adequate equity-capital gives companies better odds at maintaining their leadership roles, especially when the inevitable stumbles come along.
Bill
William A. Stong
Email: william.a.stong@gmail.com
SBF&P # 69
Telephone: 925-202-6244
Copyright © 2010 Integrated Profitability TM
Captial Ratios: Safety Margins (1 of 6)
March 11th, 2010
Copyright © 2010 Integrated Profitability TM
Equity-Capital ratios that focus on a company’s safety margin are the main point of the Small Business Finance & Profitability Equity-Capital series:
● How large is your financial cushion?
● Are you well-capitalized?
Here are two major “safety margins” that are widely used:
Debt / Shareholder Equity
Purpose: to assess how leveraged your company is and, more specifically since debt is paid off first, how much cash is available to cover financial challenges (in the worst case, this ratio indicates how much value would be left for shareholders/owners if the company had to be liquidated)
2. Working Capital Ratio (Current Ratio)
Current Assets / Current Liabilities
Purpose: to know how well your current assets (e.g., cash) cover your current liabilities (e.g., short-term accounts payable)
CPAclass.com is a helpful website with a good list of main financial ratios.
These two ratios are useful in assessing the financial health of a company, particularly the ability to pay bills and debt. However, they are calculated from items on the Balance Sheet, not from the dynamism of the Income Statement which is where many, if not most, financial difficulties come from for small businesses.
To reiterate the benefits and uses of equity-capital:
● Funding for the business: more money can be poured into improving the company
● Weathering rough patches: money can be used to plug gaps in net-profit
● Rewarding investors: dollars can be returned to your investors
Subsequent installments of this article delve more deeply into ways to identify and quantify those rough spots—and gauge how adequate your equity-capital is to survive them. Something along the lines of whether or not you have enough tarmac to fill in the pot-holes your business might be hitting.
The next article is scheduled for April 29, 2010: during the week devoted to “Risk.”
Bill
William A. Stong
Email: william.a.stong@gmail.com
SBF&P # 57
Telephone: 925-202-6244
Copyright © 2010 Integrated Profitability TM
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