Mark G. Metzler, Director, Audit & Accounting
When economic performance suffers, many business owners focus primarily on the income statement and choose to cut costs. This was a common practice during the recession. Businesses cut discretionary spending and reduced head count with the goal of “right- sizing” the organization’s cost structure. While these efforts can temporarily boost results, there is often greater value to be found in the balance sheet. Tightly managing the balance sheet can create more cash, preserve options, and increase shareholder value for business owners.
Working capital is the best way to judge how much your company has in liquid assets to build the business, fund growth, and produce shareholder value. Working capital reveals more about the financial condition of your business than most other calculations because it shows what would be left after using short-term resources to pay off short-term liabilities. The greater the amount of working capital, the less financial strain your company will likely experience.
Companies can make poorly timed or ill-advised capital investments, or own unnecessary or unproductive property and equipment.
When you focus your efforts disproportionately on the income statement, it can be easy to miss these issues. Some measures designed to manage costs can actually inflate the balance sheet, consuming cash and reducing value.
Many high performing companies pursue a more evenhanded approach to financial management, managing the balance sheet as tightly as they manage the income statement. They take steps to free up significant amounts of cash, which can be redeployed to generate the greatest returns.
The following steps can help your company achieve this goal:
- Identify your current use of capital and track it to each product, customer, geographic segment, and activity. Without knowing where your capital is currently invested, you cannot know the true economic profitability of the products and services for which you are responsible. By focusing on the cost of capital, you can assign appropriate costs to each product or service, assess true performance, drive profit improvements, and deemphasize products or services that do not generate adequate return on capital. In essence, you will be making more informed strategic decisions.
- Actively manage working capital by limiting the resources tied up in funding other operations. For example, using lean techniques to reduce the time it takes to produce finished goods can have a dramatic impact on operations. Also, remove the bottlenecks in your operations that lead to slow collections. Utilizing powerful business process tools such as management dashboards can improve visibility into how effectively your organization operates, providing real-time information to manage the business.
- Set an implicit or explicit limit on capital expenditures based upon the performance of the business. One key to effective capital budgeting is to set targets for asset productivity. Invested capital should be more productive over time and you should expect greater output. Do not spend more capital without requiring additional output.
- Explore a new approach to the business and pursue strategies to own fewer assets, or seek third parties to own the assets for you. Assets that were previously considered essential to own can be outsourced, thereby freeing up a significant amount of cash and reducing long-term costs. For instance, instead of owning warehouses and trucks, consider contracting with companies that do so.
Ultimately, managing the balance sheet is all about freeing up cash and redeploying it in the best possible way. It provides a significant opportunity to create shareholder value, in good times and in bad.