We all know that the equity in your home can help pay to landscape that new patio, repair the leaky roof or outfit a kitchen remodel. That’s putting equity to good use.
But what about the equity in your business? Are you taking full advantage of it? To most business owners, equity and retained earnings are merely numbers on a balance sheet, so the real question might be how best to find business equity and utilize it.
Real estate and other fixed assets, for instance, are often underutilized as equity sources. Off-balance operating leases with purchase options, as an example, usually have an equity position – especially if they were originally designed to be aggressive tax write-offs.
And while most companies typically have a choice of whether to obtain debt financing or equity financing – often employing a combination of the two – there are distinct advantages to using the latter. For one, properly using equity financing can expand the capital position of the company, thus freeing up more liquid resources for the business to grow.
The preference in financing is often decided based on the company’s existing cash flow, on which possible source of funding is most accessible, and on the level of importance the owners have placed on maintaining control. The desired result in any case, of course, is to successfully establish a low debt-to-equity and debt-to-earnings ratio that’s looked upon favorably by creditors and allows the organization to take full advantage of opportunities that could benefit the company.
There are pluses to debt financing, however. Because the lender doesn’t have a current or future claim to equity or profit in the business, the debt does not dilute the owners’ rights and privileges – and/or future rewards if the company is successful. Principal and interest obligations are known amounts that can be forecasted; there are less securities laws and regulations involved in raising debt capital; and debt interest is tax deductible. Operating leases can also be attractive, as they generally require less of an initial payment and are tax deductible as well.
All debt financing, though, must be repaid at some point, and monthly debt payments should be considered as a fixed cost that raises the operation’s operational break-even point. The Fixed Charge coverage ratio (as addressed in other financial blogs) indicating when EBITDA to Debt Service is 1.5 times or greater, your company should have sufficient cushion to service virtually all future debt.
Properly managing business equity, then, can help your company attain its goals. Understanding how best to find – and utilize – such hidden equity will ensure your company has the greatest chance of long-term success. It is simply a matter of putting all of your business equity working for your behalf.