Have you ever become confused or intimidated by so-called high finance? If you are an owner or CEO of a small to midsize company and do not have a CPA or MBA, don’t be intimidated. You only need to understand the fundamentals of what finance means to you and your business, and that is not all that difficult. We will go into just a few basics.
Here’s what you really need to know.
Liquidity. You need to have enough money to operate your company by meeting payroll, paying your bills and getting enough money through the door to do that. If you are short for a limited period of time, that is where loans, a line of credit, extending your payments, your cash reserves, and a rich uncle, etc. come in handy. This is called liquidity. Most financial institutions use a shorthand method of doing this, which is called the current ratio — your current assets divided by your current liabilities. A ratio of around 2:1 is usually satisfactory; it was 1.5:1 a while ago, but just think of the simple concept of having enough money to pay your bills with a safety factor, to cover any surprises. But your local bank will set its own standards and various industries have their own benchmarks.
Risk. Another financial barometer that you might want to focus in on is how much skin you have invested in your business compared to what the bank has invested. If you are only minimally at risk, you might not look like a good credit risk to a bank. Think of it as a mortgage where you could get a loan with little or nothing down; the bank had all the risk, which it soon packaged and sold to unsuspecting investors, which in turn led to the near-collapse of our economy not so long ago. Well, those shenanigans are over. You need at least 20% down with a lot of scrutiny to get a loan today. For a company, your total debt-to-equity ratio is a shorthand way to test how much relative risk the bank wants to take. This is about 2:1, while it was about 3:1 in earlier periods. Here, too, your bank will come up with values that it is comfortable with by business sector.
There are indeed many more financial things an owner or CEO needs to be looking at to run his or her company. This includes the granting of credit in terms of both a dollar amount and length of time for payment; the collection activity, which is often an outgrowth of one’s credit policies; financial risk mitigation in such areas as workers’ comp, general liability and much more. But if you ask your controller or VP of finance to get a clear answer to your questions and don’t accept financial jargon as a response you really don’t understand, you will go a long way to getting a grip on what you need to know about high finance.
