When it comes to business, risk is par for the course.
Whether you’re considering calculated risks, anticipated ones, or events that seem to come out of nowhere, how well positioned you are to handle risk is an important factor in your business’ overall health.
And access to cash plays a key role in easing risks to your business.
Here CWB’s Graedon Rust, Senior Relationship Manager, Commercial, based out of our St Albert Banking Centre, gives a high-level primer on determining a business’ ability to withstand challenging cash management situations, as well as some considerations for your business and financial strategy.
Ability to mitigate risk
Factors that affect it: “There are a couple of key factors that can really impact your financial ability to deal with risk,” says Rust. “The first is your growth rate, or the percentage rate at which your revenue is increasing. The second is the amount of leverage you have, or how much debt you’ve used to finance your assets.”
How you measure it:
Year-Over-Year (YOY) Revenue Growth
“This allows you to compare revenue from various periods – such as annual, quarterly, and monthly performance and gauge how quickly you’re growing, as well as how seasonality may be affecting you,” says Rust. “A healthy or unhealthy growth rate is very business dependent, however the underlying issue is working capital. If the business is growing too fast to sustain their working capital they are going to have less ability to mitigate risk.”
Debt to Tangible Net Worth Ratio
“A higher Debt to Tangible Net Worth Ratio shows there is more debt in the company,” says Rust. “A lower ratio shows there is more equity. What’s considered a healthy ratio depends on the industry.”
How you calculate it:
YOY Revenue Growth
Current month’s sales number – sales # from the same month last year
___________________________________________________________ X 100
Last year’s total sales
Debt to Tangible Net Worth Ratio
Total liabilities – postponed shareholder loans
Equity – (intangible assets + postponed shareholder loans)
How growth rate and leverage impact your business banking:
High growth companies
While high year-over-year growth can be a great thing for your business, it can also bring challenges and remove some ability to deal with unexpected circumstances and complications, says Rust.
“High growth companies often run through their working capital to support their growth. They’ll also generally need larger loans than their financial statements show they’re capable of paying back. This makes it difficult for lenders to agree to extend more funds to them,” he says. “CWB offers margined operating lines to share the burden of working capital and cash flow challenges, however this is expected to be split between the company’s equity and bank debt. So if revenues grow too quickly and the equity portion of that ratio has not had a chance to grow, a company can become offside on its Debt to Tangible Net Worth covenant as well as its operating line margin.”
High leveraged companies
“High leveraged companies have more debt than equity and will have a more difficult time meeting their debt payments during slower periods, says Rust. “They’ll also be unable to access new debt if a growth opportunity emerges.”
He adds small businesses need to grow carefully as they’ll generally run into the growth trap before the leverage trap because banks will typically limit what they’ll lend to them.
“Often challenges emerge when profit margins differ on a per job basis, which can be especially common in the construction industry. As these companies grow, their margins shrink and unexpected complications reduce their margins even further,” says Rust. “This can be mitigated by having good estimation procedures in place and fully understanding the costs of each job.”
“It’s best to take a measured approach to growth rather than a rapid one,” say Rust. “While it may seem like a great idea to take on multiple large projects, there are often unanticipated challenges that come with growing quickly, and that can impact your cash flow and ability to handle risk. You’ll also want to keep your debt low enough to be manageable in challenging times.”
Solutions that CWB offers:
Related tools and resources: