Balancing your balance sheet

Introduction

In this final instalment of our series on building resilience in uncertain times, we delve into the crucial aspect of balance sheet resilience. As we have discussed in previous articles, businesses today are facing a myriad of challenges, including inflation, interest rates, commodity prices, and rising costs. Understanding and strengthening the balance sheet is essential for businesses to navigate these turbulent times and ensure long-term sustainability.

What is balance sheet resilience?

When we talk about balance sheet resilience, we refer to the ability of a business to withstand and adapt to financial challenges effectively. It means having a capital structure that aligns with your strategic needs, allocating capital wisely, and actively managing performance, liquidity, and risk.

How does one identify an unhealthy balance sheet? 

Detecting a deteriorating balance sheet is crucial to taking proactive measures. Unfortunately, such erosion often goes unnoticed until it's too late. Slowly diminishing margins, returns, and liquidity squeezes can lead to short-term actions such as accumulating more debt, delaying payments, or selling assets at discounted prices. To prevent this, conducting a balance sheet ‘health check’ is vital. This health check would entail assessing liquidity, solvency and leverage ratios, as well as evaluating returns on invested capital (ROIC) versus the cost of capital to determine the value-added nature of your assets.

How to build balance sheet resilience?

1. Proactively refinance: 
   Review your borrowings and consider refinancing options that align with your business goals. Assess your working capital facilities, short-term versus long-term debt, and the feasibility of consolidating borrowing facilities to simplify the process. 

2. Establish financial buffers:
   Create a cushion to withstand potential shocks over time. Develop risk mitigation processes for currency, interest rate, and refinancing risks. Re-examine treasury management practices to protect liquidity. Ensure your teams have the necessary capacity and skills to navigate complexity effectively.

3. Align with business objectives:
   Regularly review key performance indicators (KPIs) to ensure they align with your long-term objectives. Track performance and balance sheet health by utilising / leveraging existing requirements such as going concern reviews and monitoring financial covenants.

4. Stress testing:
   Conduct stress testing exercises to assess the impact of various scenarios on your balance sheet, particularly given increased uncertainties. This helps identify weaknesses and enables proactive planning for potential challenges.

What strategies can businesses employ to source funding in a risk-averse environment? 

• Utilise internally generated cash flows as the primary source of funding to sustain operations. This may entail innovating on a business ‘unusual’ basis to unlock value within your business to enhance your attractiveness to potential funders.

• Start with your existing lenders and transactional banking relationships to explore funding options. However, also expand your search beyond your current funder to increase competitiveness and flexibility.

• Consider sustainable financing options to lower funding costs while driving environmental, social, and governance (ESG) improvements.

There’s a lot to be said of the ‘softer side of things’

Effective communication with stakeholders plays a vital role in building balance sheet resilience. Regular interactions foster trust and understanding among management, employees, the board, lenders, shareholders, customers, suppliers, and regulatory authorities. Transparent communication helps address concerns and ensures that stakeholders are prepared for potential risks or challenges. It fosters a sense of goodwill and confidence, creating a strong support network during times of financial uncertainty.