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Monday, December 22, 2014

Cash May be King But Post 1

Posted by William on March 30, 2011

Most people will tell you cash is king and they are right. Cash is probably your most precious asset and whether you have an abundance of cash or a lack of it, cash management is a key to staying a float. However, because of rapid growth in the computer technology channel, cash may take a back seat to availability in terms of actually running your business.

In analyzing the historical financials of companies that went out of business, it was discovered that all showed declining availability over two years prior to their demise. In looking at “troubled” companies today, we consistently see marginal, if any, availability. Studies have shown that healthy availability levels are also a sign of a healthy company. So, how much availability is needed? A good rule of thumb would be to have availability in excess of one months of operating expenses.

What is Availability?
Availability is the total of cash plus lines of credit less any outstanding balances. Availability can best be explained by looking at your personal checkbook. Let’s assume you have a cash balance of $8,500 in your account and you also have overdraft protection or, a line of credit. The line of credit is for $10,000 and you have an outstanding balance of $2,000. Under this scenario you would have availability of $16,500, calculated by adding cash and line of credit together and subtracting the outstanding balance on the line of credit. Essentially, you can write a check for $16,500 without bouncing the check.

When evaluating your company, this principal remains the same: cash plus lines of credit minus outstanding balances is equal to availability. As illustrated in exhibit A, a company with $150,000 in cash and a $1,500,000 line of credit with an outstanding balance of $1,250,000 would have availability of $400,000. Although the principle of availability is quite simple, there are some other factors to consider such as a company’s borrowing base and collateral value of assets. The borrowing base is the estimated collateral value of a company’s assets.

Finance companies and banks have many different ways of calculating collateral value. For instance, a company’s borrowing base could be determined by the collateral value of its inventory, the collateral value of its fixed assets, the collateral value of accounts receivable or any combination there of. In order for a company to include all of its line of credit, the company has to have sufficient collateral.

Many times a company may have a $1,500,000 credit facility but, because of its collateral value of its assets, may only have a borrowing base of $1,300,000. If the company in illustration A only had $1,300,000 in collateral value, the availability would be $200,000.

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