Building A Fortress Balance Sheet for Your Business
/Ironically, the worst time to approach a bank for a loan is when you're in desperate need of one. To increase your chances of getting the necessary support, it's essential to build a fortress balance sheet long before you request a loan. The fortress balance sheet concept involves utilizing banking analytics to develop a balance sheet that impresses not only your banker but also potential investors. Here are three key concepts to consider when constructing your fortress balance sheet:
Debt-to-Equity Ratio: This ratio is calculated by dividing total liabilities by total equity. The goal is to have significantly more equity than debt, aiming to get the ratio below 1.0. When your equity outweighs your debt, it portrays a financially stable position.
Debt Service Coverage: A fortress balance sheet ensures you have enough cash to cover debt obligations and more. Calculate your earnings, add back interest expenses and non-cash items like depreciation, then divide this number by your debt service payments. A ratio below one indicates potential financial trouble, while a ratio over two signals a healthy financial standing.
Liquidity: Cash is king, and it is crucial to have a balance sheet that is rich in liquid assets. Avoid having excessive unused equipment or other non-liquid assets. The goal is to have sufficient current assets to pay off short-term liabilities promptly.
Strategies to Build Your Fortress Balance Sheet:
Manage Inventory and Receivables: Efficiently control inventory and receivables to avoid the need for additional debt to fund your operations.
Adopt a Banker's Perspective: Continuously monitor and improve your debt service and debt-to-equity ratios. Consider reducing shareholder distributions to maintain a healthy equity balance, minimize the use of credit lines, and cut unnecessary costs.
Eliminate Non-Performing Assets: Regularly assess your business assets and dispose of non-performing ones. This might involve consolidating locations, selling obsolete inventory, or getting rid of outdated equipment, with the aim of converting these assets back into cash.
When your balance sheet reflects a strong and stable financial position, banks and potential investors will be more inclined to seek your business rather than you having to convince them to lend you money.
Avoiding Tax Consequences When Borrowing Money From Your Business:
Borrowing money from your business may lead to unexpected tax implications if not handled correctly. To prevent disputes with the IRS, follow these steps:
Document the Loan: Treat the cash withdrawal as a loan and create a legally enforceable promissory note detailing the terms, including the loan amount, interest rate, repayment requirements, and the length of the note.
Corporate Documentation: If your business is a corporation, ensure that the loan is authorized and documented in company minutes.
Reasonable Interest Rates: The interest rate on the loan must be reasonable, and you can refer to the federal register to find the minimum published rates each month.
Proper Accounting: Record the transaction as a loan in your business's accounting system, clearly distinguishing it from other financial activities.
Evidence of Repayment: Keep records of repayment in line with the terms specified in the promissory note.
By meticulously following these steps, you can ensure that any loans taken from your business are treated as legitimate loans by the IRS, avoiding any potential tax issues.