There are many financial ratios and calculations that business owners are familiar with. Most of these are basic operating statistics that owners can, and hopefully do, use day in and day out to manage the business. Tangible Net Worth is typically not in that group but, to many owners, it is vital because it’s a metric that their bank uses in the lending covenants. Mess this one up and you’ll have a problem with your bank better known as a “busted covenant”.
What is Tangible Net Worth?
Tangible net worth is a measure of how much your company is physically “worth”. To calculate your tangible net worth, take the sum of your equity from the balance sheet and subtract the “intangible assets”. These are assets that don’t physically exist like your intellectual property (patents, trademarks, processes, etc.), goodwill, customer list, internally developed software, etc. These items can be very valuable, however, unlike cash, building, machines, etc., they do not physically exist.
Why do the banks track your Tangible Net Worth?
The banks are very concerned about protecting their downside risk with the ultimate risk being that you go bankrupt. Your tangible net worth represents an amount that they could reasonably expect to recover if something catastrophic happens. Extracting value from intangible assets like trademarks, business processes or goodwill from a bankrupt company typically isn’t feasible regardless of how valuable they are to you now. It is also a way for them to insure that there is a reasonable amount of cash in the business to prevent a future cash crunch, as cash withdraws by an owner have the effect of reducing equity and tangible net worth.
How do I manage my Tangible Net Worth?
It all starts with managing cash in a very detailed way. Many banks have quarterly covenant reporting, giving owners some flexibility in the interim time. For example, taking a planned cash distribution on October 1 as opposed to September 30 results in greater equity and tangible net worth for your Q3 reporting period. It is also very important to consider this when acquiring another company; with an asset purchase you can write up the acquired assets to full market value and reduce the amount of goodwill in the transaction. By managing cash, equity, and intangible assets you are effectively managing your tangible net worth.
I’m not in business just to keep the banks happy, how does it help my business?
While your main objective isn’t keeping the banks happy, it is a part of your overall business plan. Also, the process of managing cash on a daily or at least weekly basis is one of the most important (and rarely utilized) activities you can do for your business. Accurately projecting your cash position next week or next month takes your mind off the unknown and allows you to focus on the commercial side of your business. It also helps to know when you have a unique item on the horizon that will require a material cash withdrawal and gives you time to discuss this proactively with your banker. Looking at this sort of an analysis when doing an acquisition allows you to plan before the deal is done rather than react and scramble two months after the close.
I have a great accountant but this is just a little beyond his or her skills…what do I do?
Call me! I’ve developed and maintained cash flow forecasts at many companies, helped owners understand and utilize the detailed planning information, and worked with the banks to help companies that have had some issues. I would truly enjoy hearing more about your business and, together, determining how I can help you grow your business.
Christopher Buls – Expert in Managing Tangible Net Worth
Partner B2B CFO®
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