If you’re a small- or mid-sized business owner who is struggling to make your operation both profitable and cashflow positive, don’t beat yourself up too much! Even some of the largest corporations in this country are getting it wrong and stuffing up every day.
Take the CBA for example: one of the largest banks in Australia recently announced a $6 billion profit for 2009-10. To put this in context, this equates to around a 17% return on investors’ funds, which is impressive indeed in these tough economic times.
Too bad the CBA is technically bankrupt – meaning they don’t have enough liquid assets to cover the debt as it is coming due.
But how can this be, you might ask? The answer is simpler than you might think and it applies to all companies, big and small: profit is pointless and cash flow is king. More businesses in Australia go under every year due to lack of cashflow than any other single reason. No businesses, even financial institutions which are afforded many governmental protections and safeguards, are exempt from this basic law of the economic jungle.
From borrowing overseas to funding your mortgage
So how exactly can a company that has been able to earn $6 billion in net profit, by overcharging customers through bank fees and interest margins, be bankrupt? The answer lies in a mystical statement, commonly referred to as the Balance Sheet.
On the left hand side of the Balance Sheet we have assets – something of value owned by the company. In the case of a bank, loans and mortgages are its primary assets, and in the case of the CBA, 65% of its loans are domestic mortgages. And everyone knows that domestic mortgages are long-term arrangements – 25+ years in length.
As for the liabilities side of the Balance Sheet, 50% of the money lent out as mortgages comes from depositors (you and I) and the other 50% comes from overseas borrowings. In the case of the CBA, half of the money loaned out as mortgages must be repaid to foreign creditors. Unfortunately, a great majority of those foreign borrowings are short-term (90 day) loans.
Foreign exposure on these short-term facilities is a huge vulnerability for all Australian banking institutions and was the primary reason that Kevin Rudd introduced the bank guarantee on personal deposits in October 2008. The guarantee was not to protect you and I, but rather, the precarious Achilles’ heel on the Balance Sheets of our banks.
If you cast your mind back to October 2008, you will remember the panic that ensued when foreign creditors refused to roll over their loans to Australia’s banks. The banks of course lobbied the government to intervene with the guarantee and everyone breathed a sigh of relief.
But, it’s not over. Not by a long shot. Our major banks remain heavily reliant on overseas borrowings to fund domestic lending and they are precariously susceptible to shocks in global credit markets. You don’t need to be an economic genius to know that the US and many other markets still have not recovered from the last crisis. And if you follow the predictions of some of the leading economic advisors in the world, such as Harry Dent and Graham Dyer, you already suspect that the worst may still be yet to come.
Does the housing bubble spell trouble ahead?
Under these perilous circumstances, you would expect that CBA management would have invested/lent all short-term foreign funds in safe and stable investments. However, we all know now that 65% of the money went straight into domestic property, which is highly inflated in this country. Over the long term, the statistical mean housing values should average out to a multiple of 3.5 household income. Essentially, at 3.5 times household income, a property is said to be moderately affordable. In plain English, this means that we should expect about half of the population of a given country to be living in affordable housing.
At present, Australia is the only country in the world where 88% of the population is living in severely unaffordable housing – meaning, housing costs are more than 6 times household income. It is not hard even for a layperson to see that this inflated property position is unsustainable and will come down.
It is highly likely that 65% of the CBA’s asset portfolio is overstated on the Balance Sheet by up to 50%. If property values were to come down in this country, as they have done in Japan, the US and the UK, this would leave an up to $200 billion hole in CBA’s Balance Sheet and it would be sufficient to cause the collapse of the bank. The CBA simply will not be able to recoup the market value of its lending from the sale of the underlying assets and homeowners will be left to make up the difference on foreclosures.
And are you ready for the best part? Compared to the financial statements of the other top Australian banks, the CBA is not in bad shape. In fact, the NAB and Westpac may be in worse positions due to the volume of foreign exposure and another, more sinister evil – off-balance sheet exposure to derivatives.
So what does this mean for you and your business?
Today is the very best time to learn how to read your financial statements and turn the numbers into insights that can help to improve your business – both your profitability and cash flow.
If your business were producing a healthy return, you would have the money that you need to pay down your debt – home loans and credit cards – and you would not risk losing your home and other assets in the event of another downturn. Even if property values were to drop, you would own your home outright and not be at the mercy of the banks scrambling to foreclose on properties to shore up their Balance Sheets.
The financials tell the story of your business. Numbers don’t lie. They are one of the few objective indicators of how your business is performing and why. The numbers can lead you to the solution. You just need to learn how to use them to your advantage.
Rhondalynn Korolak is the founder and Managing Director of Imagineering Unlimited. She is the author of Financial Foreplay, a book that offers guidance to small business owners. A 16-year veteran of sales, marketing and finance, she holds degrees and professional designations in both law and chartered accounting.