The cover story in the business section of USA Today is about how IBM has managed to survive and thrive as an ongoing business entity for 100 years; a rare feat indeed. Two attributes jump out of this story. The first is constant product and service innovation, something I’ve discussed in my new video series. The other is the fact that they’ve remained financial conservative. If you’ve read my blog for any length of time, you’d realize that this is another accounting tenet I embrace.
So what does it mean to be fiscally conservative? Well for starters, you should not take on excessive debt, in good time or bad. In IBM’s case, they carry about 95 cents of long term debt for every $1 invested by the shareholders. Put into small business terms, you would hold a dollar of long term debt, for every dollar of equity. Check out your balance sheet and tell me what it reveals.
If you’re like many small business owners I help manage accounting and business finances for, you’ll probably have a 3 to 1 ratio of debt to equity. In several cases I see negative equity. Although these kinds of businesses are ongoing, they are technically insolvent. Sort of like living in your house even though you’re upside down with your mortgage. Interestingly enough, banks have historically ignored this fact, until recently. Now, the equity section of your balance sheet has come under great scrutiny, with good reason. Think about it, you could take out a long term loan for $5000, then pull out $3000 as a shareholder distribution (i.e. to pay yourself), causing a distortion of this accounting measure.
If your debt to equity measure is less conservative than you’d like, how do you correct it? Two ways: either inject more of your own money into the business, or take less of the profit out. How do you take less profit out? Give me a call.