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Your company’s balance sheet summarizes how you have performed since your company first opened its doors. At a glance, it will tell you how much money you have made over the years by comparing your company’s total assets to its total liabilities. But, like anything else in life, there is more to a balance sheet than meets the eye.

A balance sheet can tell you, for example, if your equipment is getting too old, how much working capital is available for growth and expansion, and if you may be headed for cash flow difficulties. It conveys this vital information in the form of ratios, or relationships, that you (and your bankers, suppliers, or other interested parties) can use to track current performance and trends. The following are some questions regarding business performance that owners often ask and the answers that a balance sheet can provide.

Q. I think we are having a good year, but will the company have adequate cash flow to meet current obligations?

A. Cash flow health can be measured in one of two ways, either by determining a company’s current ratio or its quick ratio. The current ratio expresses the relationship of 12-month assets to 12-month liabilities. A current ratio of less than 1.25 indicates cash flow pressure, whereas a current ratio of more than 2.25 indicates that a company may be underutilizing its funds. The quick ratio measures a company’s most liquid assets versus the total of its current liabilities. An organization’s most liquid assets are its cash and receivables. A quick ratio of less than 1.0 indicates a thin cash position, and a quick ratio of more than 2.0 means that a company is underutilizing its cash reserves.

Q. We have a lot of business and growth potential, but will I have enough capital to support strong growth?

A. Your concern is well grounded. Working capital is needed to support growth, and a fast-growing company may not be able to survive without satisfactory working capital. Determine your working capital by subtracting your company’s current liabilities from its current assets.

Q. How much money should we be investing in our company?

A. Again, the balance sheet holds the answer. The ratio of net fixed assets to current assets will tell you how much you have invested in land, equipment, and facilities compared to your company’s liquid assets, which are used to fund your working capital. Landscape contractors are generally considered healthy when the net fixed assets to current assets ratio is less than 50–55 percent. When that ratio climbs to more than 55 percent, a company has generally invested more of its resources into fixed assets than it should and could suffer from a situation of tight cash flow.

Q. How much debt should the business carry?

A. That depends on several factors. As a business owner, how much risk are you willing to take? Could your operation withstand the affects of a market downturn or an adverse business situation? Your balance sheet will reveal your debt to equity ratio (total liabilities versus total equity). If you have less debt than equity, then you are in a position with strong capital. Accruing more debt than equity is not necessarily bad; however, if debt exceeds equity by twofold, it is likely that you are trying to do too much with too little money.

Q. What can the balance sheet tell me about the age of my equipment and fleet?

A. The fixed asset newness ratio (net fixed assets over gross fixed assets) measures the current depreciated book value of a company’s assets against the original purchase price. An extremely high newness ratio may indicate that a company has dedicated too much capital to fixed assets, which may put it under cash-flow stress or debt-service stress. An extremely low newness ratio may indicate that a company is not investing enough in new assets, which may result in more equipment downtime and lower productivity.

Q. A contractor friend recently asked me what my “Return on Investment” (ROI) is for my business. When I told him I did not know and, furthermore, did not see why I needed to know, he just shook his head. If my business is profitable, why does my ROI matter?

A. Your ROI is the ratio of your net profit to your net worth. There are two good reasons to know this figure. If your ROI is less than what your money can make in traditional investment opportunities, then you may want to consider selling your business and investing your money elsewhere. Conversely, if you have a healthy ROI, then continuing to operate your business (even if there is an attractive offer to sell) may be the financially smart thing to do.

Q. Is there a standard or average ROI for landscape contracting companies?

A. No, there is not. Like with any other investment, the higher the risk, the higher the reward. For example, construction work offers many opportunities to make profits in a relatively short period of time, but there is greater risk associated with the work. This risk factor is compounded by the higher equipment/capital requirement per revenue dollar generated (as compared to maintenance). To offset risks, landscape contractors oftentimes realize a higher profit percentage on construction work than they normally would on maintenance work.

8/04

By Tom Oyler, Wilson-Oyler Group, Thousand Oaks, CA