Buttressing the balance sheet.For Sudbury area business owners, the sudden and unexpected downturn Downturn The transition point between a rising, expanding economy to a falling, contracting one. downturn A decline in security prices or economic activity following a period of rising or stable prices or activity. in the mining sector brought on by recent labour disputes underscores the importance of maintaining strong working captital positions in good times. These disputes have left several Sudbury mining contractors over-extended and unable to borrow sufficient working capital to weather the drop in demand for their services. The good news is that these companies are typically well-managed and competitive and will emerge stronger than ever, once demand strengthens. The lesson from this unfortunate situation is clear: a principal financial management objective today should be to improve liquidity to protect against unforeseen demand shifts, which in today's changing economy can happen overnight. That means building cash reserves Cash reserves See: Cash investments cash reserves Investment funds that are held in short-term assets such as Treasury bills and certificates of deposit until more permanent investment opportunities are available. , maintaining strong operating lines and reducing liabilities on balance sheets. Owners with healthy businesses can protect their firms against unexpected drops in revenues and position themselves to take full advantage when opportunities, such as the right strategic acquisition, comes along. The classic methods of enhancing working capital are, of course, paring back inventories, shortening terms on receivables Receivables An asset designation applicable to all debts, unsettled transactions or other monetary obligations owed to a company by its debtors or customers. Receivables are recorded by a company's accountants and reported on the balance sheet, and they and include all debts owed and delaying or moderating plans for expansion or new equipment purchases. Less well known, perhaps, is that companies with strong cash flows can also improve liquidity by structuring debt on a long-term Long-term Three or more years. In the context of accounting, more than 1 year. long-term 1. Of or relating to a gain or loss in the value of a security that has been held over a specific length of time. Compare short-term. , non-demand basis, in the form of term loans or subordinated debt Subordinated Debt A loan (or security) that ranks below other loans (or securities) with regard to claims on assets or earnings. Also known as "junior security" or "subordinated loan". . Unlike short-term Short-term Any investments with a maturity of one year or less. short-term 1. Of or relating to a gain or loss on the value of an asset that has been held less than a specified period of time. "demand" loans, these instruments strengthen working capital because only the current portion (the amount owing during the current fiscal year) shows up on the balance sheet as a current liability. One of the key advantages of subordinated debt is that, in most cases, bankers will treat the remaining portion of sub-debt as equity when calculating debt/equity ratios Debt/Equity Ratio A measure of a company's financial leverage calculated by dividing long-term debt by shareholders equity. It indicates what proportion of equity and debt the company is using to finance its assets. . A company with strong cash flow can improve liquidity by: Arranging term or subordinated loans In the field of finance, a subordinated loan is a type of loan which ranks after other debts should a company fall into receivership or be closed. It is also known as subordinated debt, or as junior debt. for any fixed assest originally purchased using an operating line of credi, maximizing long-term debt Long-Term Debt Loans and financial obligations lasting over one year. Notes: For example debts obligations such as bonds and notes which have maturities greater than one year would be considered long-term debt. by borrowing against other existing fixed assets fixed assets npl → activo sg fijo fixed assets npl → immobilisations fpl fixed assets fix npl → and adding to cash reserves and replacing short-term, "on-demand" loans with long-term, not-on-demand loans. The benefits of a strong working capital position are numerous. Banks look favourably on companies with good liquidity and, in some cases, may even offer lower interest rates. Also, if a business that structures long-term debt to improve working capital does get hit with a drop in revenues, it is in a much better position to negotiate new demand loans or arrange alternative forms of short-term financing. Term and sub-debt loans are business loans, not asset loans. Cash flow, market position and quality of management are the key criteria. As a result, a decline in cash flow makes it more difficult to qualify. The experience of an Ottawa-area printing company illustrates the point. This company almost went out of business in the 1990-91 recession because it had just completed a large expansion when its market collapsed. Fortunately, the company's owner was able to pare back his organization, negotiate deferred principle payments with its term lender and ride out the recession. In 1995, at the height of the recovery, the company acquired two multi-minion dollar presses using lease financing. This time, however, the owner also opted to use long-term financing Long-term financing Liabilities repayable in more than one year plus equity. to protect his working capital position and arranged a $2 million equity investment to maintain his cash reserves. A down-turn did not occur, the company hit its growth targets, and the owner paid off his investor over five years. Another option this owner could have explored was the use of subordinated debt to strengthen his working capital. The important point here is that this owner used the strength of his firm's cash flow to attract long term financing as a hedge against an unforeseen decline. Some companies may question the wisdom of taking on more long-term debt to build cash reserves. After all, long-term debt puts additional pressure on cash flow.. The important things to bear in mind are that no one ever went out of business because they had too much liquidity, and the winners in the changing economy will be businesses with the cash to capitalize on Cap´i`tal`ize on` v. t. 1. To turn (an opportunity) to one's advantage; to take advantage of (a situation); to profit from; as, to capitalize on an opponent's mistakes s>. opportunities and weather demand shifts. Norman Meunier is assistant vice president of RoyNat Capital at Sudbury's, a specialist lender to SMEs. |
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