When It’s a Bumpy Ride

Steve Steele, Financial Services Practice Leader - August, 2022

On a recent, bumpy flight back to Denver, I thought of the aviation maxim: “Don’t overcorrect in turbulence.” Change and uncertainty — like flying through cross winds and rough weather — are unsettling. Sometimes, change tempts us to push as hard as we can in the opposite direction. But as every experienced pilot knows, overcorrecting can cause a loss of control.

Inflation is the highest it has been since 1982. Most of you were not in business then, but I was. What left an impression on me was how difficult it was to maintain profit.

A turbulent market is a new challenge for today’s business owners. They’re rightfully concerned about the trajectory of the economy, though many are unprepared for the impact interest rate hikes and inflation will have on their organizations, customers and employees. Overcorrection may exacerbate the impacts of a challenging economy but small corrections, with an eye on the horizon, can help you ride it out.

Here are five steps you can take to stay on course:

1. Evaluate Your Debt-to-Equity Ratio

Your balance sheet ratio — total liabilities divided by total owner’s equity — is one that bankers look at determine loan worthiness. Companies that are over-leveraged may be able to make current loan payments in a good economy but could struggle to continue doing so if regular monthly cashflow declines. Companies with a high debt-to-equity ratio may consider refinancing debt into a lower monthly payment or leasing vehicles and equipment rather than buying and reinvesting profits into the company. Companies whose ratio is over 2 may have trouble securing a bank loan or line of credit.

2. Cash is King

The saying, “the person with the gold makes the rules” holds true for cash. Companies with excess cash have added leverage and more options — like buying outright rather than financing or putting that cash to work for the business, while remaining liquid enough to weather a rainy day — or year. Also, a strong cash position allows you to borrow at a lower rate than the market returns available by investing excess cash. The quick ratio — cash, receivables and marketable securities divided by current liabilities — should be between 1 and 2. More than that may be too much cash on hand that could be put to better use. Less than 1 and the company is probably struggling to pay its bills. Bankers and other interested parties will check this ratio to quickly evaluate a company’s financial health.

3. Prune Your Client List

Understanding your client’s total economic value is critical. What is the income and cost across all selling divisions? Is the account a good fit? The economic cost of an account is the difference between what a company makes servicing a current client versus what they could make by servicing a different, more profitable one. Pruning the less profitable allows growth and a more efficient use of assets.

4. Nix the Overtime

Overtime is a necessary evil, especially now that it is so difficult to hire and retain staff. Avoid becoming ambivalent to it, though. Put basic requirements in place that control and curb overtime. Verify scope creep or work habits are not requiring more job time than necessary. Require management approval prior to overtime being worked, and verify that routing and scheduling are accurate and as tight as possible. Labor is a company’s biggest expense. Controlling it pays huge dividends when managed correctly.

5. Maximize Internal Efficiencies

It is easy to forget that charging higher prices is not the only thing that can help offset the margin erosion that accompanies higher direct costs. Looking internally and finding improvement opportunities — less overhead, better processes, less waste — can often add margin back to the bottom line as well. Ask employees which tasks are the biggest time wasters and eliminate them or improve processes. Maybe it won’t be necessary to add that new person after all.

When these five financial best practices are an operating norm, you will be better positioned to weather economic storms and cruise to greater profitability during times of economic growth.

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