Beyond the Income Statement – Why Capital Structure Matters
The Income Statement is often a place of disproportionate focus for business owners. Many use it to assess questions like “Am I cash positive?” or “Am I able to spend like I want and pay my bills comfortably?” as a barometer for business health. While the Income Statement does provide a view of historical (e.g., monthly, annual) performance, much more is needed for effective strategic planning – proactive planning that looks beyond what the business will do in the short term to where you want it to be in five years, ten years, or a similar timeframe.
Effective strategic planning first requires owners, who tend to get heads down running their business, to pause and articulate what they want to work towards. Grow the business? Sell it in a few years for a good price? Hand it off to children when retirement time comes? Whatever the answer may be, the right plan supported by the right capital structure and sufficient time for execution must be carved out to get you there. Putting off planning and neglecting capital structure will severely reduce your options and put your exit or transition picture at risk.
Capital Structure Scenarios
Capital structure refers to the blend of debt and equity used to fund your company’s operations, growth, and broader strategic plan. Both debt and equity have their place and there is no one-size-fits-all approach. Without a solid capital structure in place, your business faces plateauing, difficulty in weathering market swings, lower market value, increased risk, and other undesired outcomes. Let’s look at a few anonymized but actual scenarios.
- The owner of this seasonally oriented service company builds up cash in peak periods to get through slower months and has ~$1M sitting stagnantly in a bank account as a result. They’d like to grow the business but don’t know where to start. | Key Questions: How do we establish a cash forecast for managing the company’s cash wisely? Can a Line of Credit be established to manage known business fluctuations? How would freeing up stagnant cash enable growth and reduce personal risk?
- This hospitality business owner approaching retirement didn’t want to sell the company he built for more than 20 years for < $10M but valuation showed it would only yield $3-4M in the market. | Key Questions: Instead of funding retirement via sale, can the significant equity built up in the company be gradually taken out to re-invest personally? Can short-term financing be established that transitions naturally to a longer term loan as the business winds down?
- This owner focuses on maximizing profit and minimizing tax liability with reporting and operations directed at those aims. They extract money via payroll and distributions, haven’t thought much about long-term goals for the business, and don’t have a plan for growth. They’re experiencing burnout, seem stuck, and feel like they’re constantly working. | Key Questions: What are the owner’s goals for the business and for himself? Does he have the needed mix of internal capability and external resources to alleviate his management burden, open new opportunities, and gain flexibility?
Many owners mistakenly believe that there is only one right approach to achieving their objectives. They believe that selling their business is the only way they’ll be able to get their cash from it. They believe they need to hoard cash to brace for troughs. They believe they need to do almost everything themselves. In most cases, there are many options. The common thread in each of the scenarios above is that achieving a successful outcome requires a well-formed plan, sufficient time (and expertise) to execute on it, and a supportive capital structure. Last mile decisions typically translate into less than optimal last mile options.
Getting Guidance that Illuminates Options
As a former partner in a private equity firm, many owners who engaged with us to sell or seek investment in their company had some combination of a broker, CPA, and/or attorney assisting them. What they didn’t have was an experienced CFO that understood the lens that potential purchasers and investors were looking at the company through. As a result, I witnessed time and time again owners who received far less for their company or significantly less attractive terms than they could have with the right guidance and a better approach to capital structure.
A fractional CFO serves as an expert guide for business owners. They understand both the financial and non-financial factors driving the value of your business. They ask, “Where do you want the business to go?” and “What do you want to happen when you get there?” They understand how to advise and act on strategic and tactical decisions to help you reach that point – to reduce expense structure and improve cash flow, improve cash flow forecasting, achieve liquidity and flexibility, and build profitability within a proactive plan for the future.
Information and Insight that Supports Your Objectives
The Income Statement paints an important picture of your company’s expenses, revenue, gains, and/or losses over a given period. However, it should not disproportionately serve as a gauge for whether your business is moving in a direction that brings you closer to where you want it to be in the future. Clearly articulate your business and related personal goals, objectives, and wishes. Get access to expertise who understands all of the variables involved and can present you with all available options. Use that to develop and carry out a forward-looking strategic plan that’s supported by the right capital structure.
It’s been said that the best time to plant a tree was 20 years ago and that the next best time is today. The same sentiment can be applied to your business. Do what’s needed now to put you and your business in the best possible position down the road.
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