By Julie Eisenhauer, CPA
Are your company’s financial matters in order? Have you adequately addressed its financial risks? These are important questions your company should be answering regularly to address financial matters and enhance business value.
A strong financial house supports growth and sustainability – enhancing the value of a business. The following are key areas that should be considered when evaluating your company’s financial strength.
How would you rate your company in terms of being “audit ready”? Even if an outside accounting firm does not audit your financial statements, it is good business practice to have effective financial reporting processes in place. This ensures accurate and timely financial reporting.
Audit readiness improves the quality of financial information, which leads to better data for decision-making. Being “audit ready” means having reliable documentation available to support the financial statement balances, documented accounting policies and procedures that are consistently applied; effective segregation of duties; and proper data retention policies.
If a potential buyer of your business dropped into your office without notice and offered big dollars to purchase your business, would you be able to respond to their financial due diligence requests in a timely manner?
Delays in responding to questions about the financial information of a company can cause investors and owners to doubt that sufficient accounting functions are in place and operating effectively. Does your company provide your investors and owners with proof that your company has a healthy and standardized reporting structure?
Do you have a stable banking relationship that provides access to sufficient capital for running and growing your business? Is the company financially strong enough to pass the analysis a lender performs when approving a loan?
One area a lender will review is the company’s ability to generate cash flow to meet debt obligations. Lenders will typically review a company’s past three years of cash flow performance and compare it to the projected debt service requirements.
A common metric for evaluating cash flow is the debt service coverage ratio, which is defined as net income before interest, taxes, depreciation and amortization, divided by projected debt principal and interest payments, over the next twelve months. A debt service coverage ratio less than one depicts negative cash flow. Most lenders require a ratio of at least 1.2 times.
Lenders also like to see sufficient equity in the company, which is necessary for surviving a downturn. If the company were to become unprofitable for a period, the lender needs to feel confident that the company won’t run out of cash while it works to restore itself financially.
A company with sufficient capital also demonstrates that ownership is invested in the company’s success, or has the “skin in the game,” to work through difficult financial times.
Have you protected, or limited, your company from risk? Regardless of size, all companies face business risk. Therefore, every company should evaluate how it can best limit its risk.
Implementing a risk management program that identifies threats, assesses the vulnerability of the business to the threats, manages ways to reduce the risk, and monitors for continual improvement, can protect a company.
Your company’s risk management program should align strategically with executive management’s risk appetite. Both department management and executive management should participate in the process of identifying threats and assessing vulnerability. Department managers have specific knowledge of issues and unique business risks that affect their department. This insight can be a valuable addition to the discussion.
Management should take a broad view when identifying and assessing the risks that could potentially affect the business negatively. Risk management is more than protecting physical and financial assets; it includes protecting a company’s reputation, its employees, and its customers.
The Clark Nuber Core Value methodology can assist owners and management in assessing their company’s financial strength and identifying opportunities for improvement. Implementing best practices in financial reporting, capital management, and risk assessment procedures establishes the oversight and discipline necessary to drive business improvement and enhance its value. What steps are you taking to enhance your business value?
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