Getting the Value Out - Part 3

by John Dunlavey

In this third in the series on building value, we will spend some time with the balance sheet and the income statement.

Most shop owners we meet are a pretty savvy group, having endured tremendous obstacles along the road. Many, however, are not clear as to how to read financial statements.

Most owners have a bookkeeper to keep track of the cash, receivables, payables and the payroll. Maybe he has a controller who is concerned about profits, cost control, and banking relationships. His outside accountant gives him tax advice and prepares the tax return and financial statements. But it is the owner’s responsibility to know what the statements mean. Unfortunately, more often than not, that is not the case.

In this article we will point out some of the things your statements are trying to tell you.

Balance Sheet

Your balance sheet is concerned with two things: solvency and safety. The ratios tell the story.

Solvency:
The ability to pay your bills as they come due. A current ratio of 1:1 means you have $1 of current assets (cash and anything which will be converted to cash within a year, such as receivables and inventory) for each $1 of current liabilities (amounts due within a year). If you have an acid test ratio of $1 of cash or cash equivalent for each $1 of current liabilities, you have met a tougher test, and your company is more solvent. A prospective buyer looks for solvency.
Safety:
The ability to withstand adversity. All businesses face adversity. Competition, weather, sales downturns, labor unrest, sudden cost increases, death and disability occur in all companies. The relationship between your debt and your equity determines your ability to overcome adversity. As we all know, Assets - Owners Equity = Debt. If you have excessive debt in relation to your own equity, you have little chance of weathering the storm.

How can you add equity?

If none of these methods looks practical, the only other way to increase equity is to make more net profit and keep more of it in the company. This brings us to the Income Statement.

Income Statement

The Income Statement has been called the race between the Inflow and the Outgo; a race to the bottom line. When times are tight we go into survival mode, cutting expenses where we can, laying off people and cutting rates and markups to try to keep our share of the business. When times get better overhead tends to "creep" back up, getting out of whack in relation to sales. It is during good times that the seeds of destruction are planted.

Here’s how it works: In order to increase sales we grow the company, adding equipment and other assets. We finance these increased assets by drawing on the bank line. Total debt starts to rise in relationship to equity. Remember, the balance sheet always balances. As the business brings in more gross profit dollars, we are tempted to spend more and perhaps to draw a bigger salary. One culprit may be the company accountant who tells us that we now have a tax problem and should spend some money. At any rate, profits which could have gone to the bottom line don’t, and the debt - equity ratio gets lopsided.

When assets increase faster than owner’s equity, the company is headed into trouble. The owner is happy because he thinks his company is growing and becoming worth more. His banker, on the other hand, is starting to have sleepless nights.

The prospective buyer sees a company becoming more vulnerable to adversity, and adjusts his offering price down to reflect the greater risk of failure.

If these questions cause you heartburn, an evening course on reading financial statements at a local community college and a review of the Benchmarks printed in the December 1996 issue of INSIGHT are in order.

Next month we will discuss the Cash Flow Statement - the key statement that a potential buyer wants to see.

(Editor’s Note: We are currently developing a succession planning manual that will be available through INSIGHT. Any shop owner interested in participating in a "beta" version of this guide should call Charlie Baker at (800) 860-2744.)

John J. Dunlavey provides services to owners of collision repair facilities and their jobbers. He can be reached through the INSIGHT web site at: www.collision-insight.com or call (800)860-2744.

Reprinted from the January 1998 Issue of Collision Repair Industry INSIGHT.

© 1998 Collision Repair Industry INSIGHT. All Rights Reserved

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