The Importance of a Strong Balance Sheet
In times like these, we learn the business lessons that stick with us for the rest of our lives. One lesson I think we’ll see is that the tire dealers who kept all of their technicians and best sales people employed during the pandemic will recover faster than those who did not.
Another lesson is that the customer loyalty you earned by doing the right things over the years will tide you over during the rough times. And the third lesson, from a financial perspective, is that having a strong balance sheet helps tire dealerships survive downturns better.
As of this writing, nearly 40 million Americans, many of them already living paycheck to paycheck, have filed for unemployment. This figure is twice the number that occurred in the 2008-2009 economic meltdown. Stay-at-home orders have caused a huge drop in spending and travel. With much of our economic growth driven by consumer spending, and with so many consumers now jobless and struggling, until they have money and breathing room, it’s going to be a slower climb out of this trough than any of us would like.
A prudent approach for tire dealers is to hope for the best but plan for a long slog. Try to not get too far ahead of the consumer.
Staying liquid. Conserving your cash and strengthening your balance sheet might be some good goals to set and hit in the near term.
Don’t be afraid to get back on that strategic growth plan if opportunities present themselves. But analyze the risk just a bit more thoroughly than you used to and make the decision with an eye towards the impact it will have on your financial strength.
We focus a lot on the P&L sheet in the tire business and not nearly enough on the balance sheet. So what defines a strong balance sheet? Let’s run it down:
First, a strong balance sheet means managing towards an adequate, smart and appropriate level of working capital (current assets minus current liabilities). How do you get to a smart level of working capital after business fully opens? Save more and spend less. Collect early and pay late.
Next on the balance sheet, you need to examine your assets. Are they income-producing and productive assets? This applies to inventory, equipment and lines of business. If those assets and lines of business are not contributing positively to income, think about dumping them. I once ran across a tire dealer who started as an exhaust system specialist before expanding into tires and undercar service. Fast forward a few years and he rarely sold exhaust anymore. But every back room of every store was jammed with obsolete pipes and mufflers and no tires. I would have sold the pipes for scrap and made room for tires.
Lastly, a strong balance sheet employs a balanced capital structure. Having access to capital is one of the primary benefits of being a for-profit company. But access to capital options varies with the size of the business. The larger the business, the more capital options that are available. A balanced capital structure means having some equity and some long-term debt, not so much debt that it puts your existence at risk. I’ve observed that some of the best-run tire dealerships have little or no long-term debt.
Finally, a word about banks. Good banks will help you during a downturn and bad banks will cut and run. And having a good banking relationship is important even when you don’t need the money. It’s like having a safety valve. During the recent Paycheck Protection Program, some tire dealers who had no current banking relationship also had no bank to submit their application to.
Over the long run, tire dealers with strong balance sheets should win over those without.
To a certain extent, you take a gamble in business today. Take picking a new store location, for example. You can look at a new location’s demographics, map the competitive environment, analyze traffic counts and then take the leap of faith and make the investment. Despite all that analysis, sometimes the store is a dog from day one and a dog forever. You need to be able to withstand that hit, and a strong balance sheet helps with that.
To me, having a weak balance sheet is a little like going to Vegas and betting against the house with only a hundred bucks in your pocket. You might win in the short run, but if you stay at the tables too long, the house will clean you out.
Michael McGregor is a partner at Focus Investment Banking LLC (focusbankers.com/tire-and-service) and advises and assists multi-location tire dealers on mergers and acquisitions in the automotive aftermarket. For more information, contact him at email@example.com.