Settling Your Balance Sheet.: Where’s the Cash?

When you want to know about your company’s financial condition, check your Balance Sheet. Integrators should aim for 60 days of cash on hand and a liquidity-to-cash ratio of 1:5 or above.

Settling Your Balance Sheet.: Where’s the Cash?
CE Pro Editors · January 15, 2013

Strong companies tend to have cash. But there’s no cash lurking on a company’s P&L, it’s on the balance sheet.

How much cash should a company have? One measure is to calculate how many “days” of cash a company typically has on hand. This is determined by dividing your average monthly sales by 30; then, dividing your average monthly cash balances by the average daily sales amount:

Average Monthly Sales ÷ 30 = Average Daily Sales (ADS)
Average Cash Balance ÷ ADS = “Days” of Cash on Hand

Sixty (60) days of cash would indicate a company could meet its obligations for a full two months, without making any sales at all. That’s a pretty healthy cash position.

Whose Cash is It?
For integration companies, some of that cash might be advance customer payments, against which work has not yet been performed. So it’s important to have Customer Deposits listed as a balance sheet liability (you “owe” your customers work-in-kind). Deduct deposit balances from your cash balance to see how much of the cash is really yours.

It’s also helpful to know how much inventory you have on hand. Some of that customer cash has probably been invested in goods that have not yet been installed. But if you don’t track inventory on your balance sheet it’s impossible to see that some or all of the Customer Deposit balance has been invested in inventory.

(I often see balance sheets showing neither an inventory asset nor a deposit liability. Not good.)

Liquidity & Solvency
Liquidity is a measure of how readily a company can meet its near-term obligations. Accounts Payable, Credit Card balances, and other items like payroll taxes, sales taxes, and short-term notes are totaled as Current Liabilities on the balance sheet.

Current Liabilities are offset by Current Assets: usually cash, Accounts Receivable, and inventory. The ratio of Current Assets to Current Liabilities (“current ratio”) indicates reasonable liquidity at 1.5 or above. As the ratio gets closer to 1:1 it indicates an increasing inability to meet all obligations in a timely fashion.

Solvency is a measure of how a company has managed its debt versus accrued profits & capital (equity). Too much borrowing – be it from vendors, banks, credit cards, or all the above – can result in a highly-leveraged debt-to-equity ratio. 2:1 is fine; banks will typically lend up to 4:1. But 10:1 starts to get scary.

And if equity is at or below zero, the ratio can’t even be calculated. The only way out is to attract new investment, and/or earn and retain profits. Or – unless you’re a really good juggler – Chapter 7.

So what? You can dismiss all this, and many business owners do. But having someone who understands the balance sheet allows managers to plan and execute strategies for improving cash flow, and cash balances.

Strong companies accumulate cash, weak companies don’t. Which would you rather be?

  Article Topics

News · All Topics
CE Pro Magazine

Not a Magazine Subscriber?
Subscribe Today...It's FREE!!