Is Your Business Ready to Invest? 4 Questions to Ask First
Economic uncertainty can make business leaders cautious about their next move. Should you wait for interest rates to fall? Hold onto cash? Delay a major investment until the outlook is clearer?
You may be waiting a long time for perfect conditions. A better question is whether your business has the financial strength and flexibility to move when the right opportunity comes along.
That’s where stress testing can help. Before making a major investment, taking on new debt or pursuing an acquisition, take a hard look at how your business would perform under several different economic scenarios. Start with these four questions.
What would higher rates do to your cash flow?
Many businesses built their capital structures when interest rates were historically low. Those financing decisions may have made sense at the time, but the math can look very different as loans renew or floating rates change.
One of the first things to understand is your exposure. How much debt is fixed versus floating? When do your loans mature? What would higher borrowing costs do to cash flow? And how would your plans change if rates moved lower?
Some businesses are considering restructuring existing floating-rate loans into fixed rates to reduce their exposure if floating rates rise. This is a risk management decision, not a prediction about where rates are headed. The important question is how much rate uncertainty your business can comfortably absorb.
How much pressure can your business withstand?
A good stress test shows you what happens when conditions move against you.
Revenue is an obvious place to start. What happens if it falls 20 percent? What if a major customer cuts back or goes elsewhere? Then look beyond revenue. Model higher and lower interest rates along with changes in the operating costs that matter most to your business.
For a company with a large transportation component, for example, a significant increase in diesel prices could quickly squeeze margins. Knowing that exposure ahead of time gives you a chance to evaluate whether hedging or other risk management strategies make sense.
You should also know your minimum liquidity needs. How much cash does the business need to operate comfortably through a difficult stretch? Once you know that number, you have a much clearer picture of how much cash is actually available to invest.
Where should your next dollar of capital go?
When conditions are uncertain, I encourage clients to look closely at what they expect each major investment to accomplish.
Some investments increase capacity or revenue. Others protect margins, reduce operating costs or make the business more resilient. Those can all be worthwhile uses of capital.
Be more cautious with large investments in speculative infrastructure or technology when the business case is unclear. If there are known vulnerabilities elsewhere in the business, protecting an important margin or strengthening the balance sheet may deserve priority.
Capital is finite. You want it working where it can make the greatest difference for the business.
Where could technology improve productivity now?
AI deserves a place in the capital conversation, but businesses don’t necessarily need a sweeping AI strategy before they can find useful applications.
Look for the low-hanging fruit. Where are employees spending significant time on repetitive work? Could technology help them analyze information faster, reduce administrative tasks or serve customers more efficiently?
Start where the business case is clear. Smaller, targeted investments can generate productivity gains today while helping your organization learn where larger technology investments may eventually make sense.
Cash gives you strength. Credit gives you reach.
Having cash doesn’t necessarily mean you should use it all to fund your next investment.
I’ve seen businesses focus so much on avoiding debt that they leave themselves with less flexibility than they realize. Cash may be needed for working capital, an unexpected downturn or an opportunity that hasn’t appeared yet. At the same time, taking on too much debt can put unnecessary pressure on cash flow.
The right balance depends on your liquidity needs, cash flow, borrowing capacity and what you expect the investment to produce. Those are much easier decisions to make when you’ve worked through the scenarios before the money is needed.
That’s also why it pays to maintain an ongoing conversation with your financial advisor. Your advisor can help you examine your capital structure, identify areas of exposure and evaluate financing and risk management strategies before circumstances force a decision.
There will always be another reason to wait for more certainty. Businesses that understand their risks, protect their liquidity and keep their financial options open are better prepared to act when an opportunity makes sense.
Chris Gruehn is a financial advisor based at Pinnacle’s Riverwood office. Chris can be reached by email at Chris.Gruehn@pnfp.com and by phone at (470) 990-8408.
