Knowing a recession is likely on the way is causing a lot of stress and concern for business owners. Taking action can help business owners regain control during uncertain economic times.
Keep reading to learn how entrepreneurs can strengthen their balance sheet now to prepare for the potential upcoming recession.
What makes a strong balance sheet
Entrepreneurs rely on balance sheets to gain perspective into a business’ total assets. A strong balance sheet provides a valuable forecast tool and helps secure funding.
Understanding how to strengthen a balance sheet helps to look at what a balance sheet needs to have to be strong.
- Good debt-to-equity ratio. The debt-to-equity ratio of a business measures how much shareholder equity is currently available to cover business debts—the lower this ratio is the better during times of economic uncertainty.
- More assets than liabilities. It’s best to have more assets than liabilities when running a business and seeing that reflected on a balance sheet is a good thing as it signals the business has more money coming in than leaving the business.
- Positive net assets. If a business has a lot of assets remaining after they pay off their obligations, then their business is in a strong place financially. Businesses with positive net assets typically perform better in periods of economic downturn compared to businesses with low net-assets.
- Strong assets. The assets that make up a balance sheet will ideally be active and have a lot of value (whether they provide value now or stand to down the road). Having a balance sheet made up of weak assets is not ideal.
- Healthy receivables. Businesses can struggle to get paid which can derail their progress. Having a large amount of income outstanding can lead to unhealthy receivables.
How to analyze your balance sheet
Now that you know what a strong balance sheet looks like, let’s examine how someone can analyze their balance sheet so they can determine what steps they need to take to strengthen it.
- Debt-to-equity ratio. You can determine what a business’s debt-to-equity ratio is by dividing total liabilities by shareholder equity. It’s best to keep this ratio as low as possible.
- Current ratio. The current ratio represents how much cash a business has available to run their operations. You can calculate the current ratio by dividing current assets by current liabilities. It’s good to have a current ratio of 1.5 or higher.
- Working-capital ratio. If you divide current assets by current liabilities, you can find out how much working capital your business has. Businesses need a positive working-capital ratio.
Tips for strengthening your balance sheet
Once you take some time to carefully analyze your balance sheet, you can determine which areas require improvement. From there, you can make a plan for strengthening your balance sheet.
Create a cash reserve
To start, it helps to have a cash reserve on hand. That way, if a financial emergency does arise (which can very well happen during a recession), the business has cash available to cover these expenses. Having a cash reserve can also make it possible to take advantage of good business opportunities that require financing.
Pay down debt
Remember that debt-to-equity ratio we mentioned earlier? One of the best ways to lower that ratio is to pay off debt. It’s also possible to lower this ratio by bringing in more sales, so ideally you’ll have a plan for increasing revenue and paying off debt. It may be possible to sell assets such as equipment or real estate to help improve cash flow and pay down debt.
It may be time to relook at the overall business budget and see where it’s possible to cut back on spending and improve cash flow. Evaluate different areas of the budget to see where your business is benefiting the most from spending and where there is room to spend less.
Optimize your accounts receivable process
As briefly noted earlier, many businesses struggle to get paid in a timely manner for their goods and services. Your businesses’ cash flow can feel the pressure when it takes a long time to receive payments. Spend time now—before the recession hits—improving and streamlining the accounts receivable process so it’s more timely and effective. Doing so can help businesses eliminate major financial stress down the road and they’ll save money by spending less resources tracking down late payments.
There’s no denying that a recession can add a lot of worry to an entrepreneur’s plate. That being said, there’s nothing individuals can do to control the course the economy takes. What they can do to regain some control is to take the necessary steps to strengthen their businesses’ balance sheet. Doing so can put their business in the best position possible to weather any upcoming financial storms.