Ever heard the term “fortress balance sheet“? Sounds like something only Wall Street big shots care about, right? Well, not so fast! Jamie Dimon, the CEO of JPMorgan & Co, coined this term to describe a balance sheet strong enough to withstand financial shocks—like those pesky contingent liabilities and covenant breaches. Think of it as a financial bunker for your business, ready to face any storm.
For small businesses, the best way to sail through turbulent times is to be prepared before the storm hits. That means building your very own fortress balance sheet. In this article, we’re going to dive into what a fortress balance sheet is all about, give you a bit of background (no boring lectures, promise!), and most importantly, show you how to build one for your business.
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What is a fortress balance sheet?
In a nutshell, a fortress balance sheet is like your business’s financial superpower cape. It’s a balance sheet so strong that it can withstand financial shocks—think recessions, pandemics, or those unexpected expenses that pop up like unwelcome guests. It not only keeps your business standing tall but also gives you the flexibility to seize opportunities when they arise. Remember, the best deals often happen when the market’s at its lowest point, not when everyone’s riding high. So, building a fortress balance sheet means taking steps to make your balance sheet shockproof by boosting your liquidity.
It’s important to note that a fortress balance sheet isn’t some fancy new type of balance sheet you need to learn. Nope! It’s about making your existing balance sheet as sturdy as a medieval castle. Picture your business as an ancient walled city, ready to fend off any siege—whether it’s a recession, a natural disaster, or surprise regulatory changes. By preparing in advance, your business can survive tough times until the skies clear or help arrives.
With a fortress balance sheet, your company can weather difficult events while still having the flexibility to deploy capital as needed. So when severe shocks hit—especially those sneaky ones that come without warning, like contingent liabilities and covenant breaches—your business can take the punch and keep on fighting. This highlights the importance of maintaining good credit ratings. In good times, your rating determines the cost of your capital; in bad times, it determines whether you can access capital at all!
The fortress balance sheet explained
Here’s the scoop: a fortress balance sheet means keeping your debt levels low compared to your equity. In simple terms, if your debt is less than 50% of the total of your debt, equity, and retained earnings, you’re building a strong foundation for your balance sheet. Think of it as having more of your own money in the game and less owed to others—a safer bet when times get tough.
Remember the 2020 pandemic? (How could we forget, right?) It hit small businesses like a ton of bricks, exposing vulnerabilities left and right. This was a prime example of a storm that a business should be prepared for by building a fortress balance sheet. But here’s the kicker: building a strong balance sheet isn’t just about dodging risks. It’s also about setting yourself up to seize opportunities when others can’t.
Healthy cash reserves can be your secret weapon. They allow your business to pounce on opportunities, expand to new locations, or launch that new product you’ve been dreaming about. But wait, there’s more! It’s also crucial to keep an eye on counterparty risk—that’s the risk that the other side of your financial transactions might not hold up their end of the bargain. This means monitoring not just your own balance sheet and credit ratings but also keeping tabs on your bank’s strategies and the quality of your banking relationships.
Want some real-world examples of companies rocking fortress balance sheets? Look no further than Coca-Cola (KO), Honeywell (HON), and Public Service Enterprise Group (PEG). These giants didn’t get to where they are by winging it!
A brief history of fortress balance sheet
Time for a quick history lesson (don’t worry, no exams!). Jamie Dimon, the CEO of JPMorgan Chase, often credits his company’s resilience in both good and bad markets to always maintaining a fortress balance sheet. Before the Global Financial Crisis of 2007-2008 hit, Dimon was laser-focused on making sure his firm’s balance sheet could withstand all phases of the business cycle. Critics called him overly conservative, even a stick-in-the-mud. But when the crisis struck and other banks were begging for bailouts or collapsing altogether, JPMorgan emerged stronger than ever. Turns out, playing it safe isn’t so boring after all!
Sure, dissecting the financial statements of a Wall Street bank can feel like solving a Rubik’s Cube blindfolded, but the core concepts of Dimon’s fortress balance sheet approach are surprisingly straightforward. And guess what? This approach isn’t just for corporate giants—it applies to individuals and small businesses too. The main ingredients? Always having enough liquidity (cash on hand) and avoiding high levels of leverage (fancy talk for not drowning in debt). This combo lets you withstand unexpected shocks and stay nimble enough to jump on opportunities when they pop up.
Teaming up with a financial advisor can be a game-changer. Not only can they help you make sense of your balance sheet, but they can also help you get your financial ducks in a row. It’s like having a personal trainer for your money habits! Together, you can build your own version of a fortress balance sheet and maybe even kick some of those bad spending habits to the curb.
Related: Debt to Capital Ratio Formula and Interpretation
How to build a fortress balance sheet
Ready to build your own fortress balance sheet? Here’s your six-step action plan:
- Control your inventory and receivables like a hawk.
- Keep a tight rein on debt.
- Monitor your credit.
- Reconcile your balance sheet accounts quarterly.
- Ditch non-performing assets.
- Crunch those ratios.
Control inventory and receivables
Let’s start with inventory and receivables—the dynamic duo that directly impacts your cash reserves.
Carrying excess inventory is like hoarding items you don’t need; it ties up cash that could be better used elsewhere. You’re paying to insure, store, and manage products that aren’t bringing in profits. Not cool.
Then there are receivables—the money your customers owe you. If clients are slow to pay, it’s like they’re using your business as a free loan. Meanwhile, your cash flow is taking a hit. Time to tighten up your credit policies and chase those overdue invoices!
Keep a tight rein on debt
We get it—sometimes you need to borrow money to make money. But there’s good debt and then there’s debt that keeps you up at night. The key is to use debt financing wisely, especially for big-ticket items like equipment or real estate that will benefit your business for years to come.
Here are two golden rules:
- Don’t borrow more than 75% of an asset’s worth. This keeps you from over-leveraging and ensures you have some skin in the game.
- Aim for loan terms shorter than the asset’s useful life. You don’t want to be paying off a loan on equipment that’s already in the junkyard.
Remember, the goal is to keep your debt as a percentage of equity as low as possible. If your debt is less than 50% of the total of your debt, equity, and retained earnings, you’re on the right track.
Monitor credit
Your business credit score is like your financial reputation. A strong relationship with your banker can be a lifesaver when the going gets tough. Monitor your credit rating regularly and address any questionable transactions that pop up. Just like your personal credit, paying your bills on time builds credibility and can open doors to better financing options.
Reconcile balance sheet accounts quarterly
We know, bookkeeping isn’t everyone’s idea of a good time, but reconciling your asset and liability accounts at least quarterly is crucial. A well-supported balance sheet helps you make informed decisions about cash reserves, debt management, inventory, and more. Regular check-ups can highlight vulnerabilities in your financial fortress, giving you time to take corrective action before small issues become big problems.
Get rid of non-performing assets
Got a warehouse full of outdated inventory or a store location that’s bleeding money? It’s time to cut the dead weight. Selling off non-performing assets can free up cash that can be put to better use elsewhere in your business. Think of it as a financial spring cleaning.
Calculate ratios
Time to embrace your inner math geek! Understanding how your bank evaluates your business through financial ratios can give you a leg up. One key ratio is the debt service coverage ratio, which shows whether you have enough cash flow to cover your debt payments. Banks love to see that you can comfortably handle your debts. Work on improving your cash flow and keep an eye on other important ratios to strengthen your financial standing over time.