Clubs need cash to operate and simply looking at your club’s cash balance isn’t enough. Measuring and monitoring liquidity are critical to understanding your ability to meet your obligations and invest in your future. Monitoring liquidity on a monthly basis makes it easier to stay on top of your club’s financial condition.
Liquidity: The Hierarchy of Priorities
Cash serves a variety of purposes in private clubs. Those uses in the order in which we believe they should be addressed are:
- Meet current obligations such as payroll, payables, sales taxes, and other current liabilities.
- Meet debt-service obligations.
- Fund capital investment needs. This includes not only obligatory capital needs (ongoing repair and replacement of existing assets), but also aspirational capital needs (expansion of the existing asset base which increases the club’s net worth over time).
- Ensure cash is available when needed. Clubs wishing to increase reserves must satiate the debt service and capital needs before reserves can be increased.
Many clubs measure financial performance with singular focus on the income statement. Some clubs will also present their balance sheet on a monthly basis. There is another tool that is often overlooked: the statement of cash flows. The statement of cash flows is broken into three parts:
- Operating Activities, which are net income, plus non-cash items like depreciation plus/minus changes in working capital.
- Investing Activities ,which are typically your capital expenditures.
- Financing Activities, which are principal payments on loans and leases along with monies received/paid from/to members that aren’t on your income statement.
An easy template can be developed to produce a monthly statement of cash flows.
Metrics
Here are two quick metrics that should be monitored regularly:
- Unrestricted cash to operating revenues. Unrestricted cash typically excludes cash for dedicated capital projects or debt service requirements. Club Benchmarking data indicates the median level of cash held by clubs equates to 15% of operating revenues.
- The Quick Ratio. While working capital is the ratio we hear about more often, the quick ratio is the better liquidity measure because merchandise inventory doesn’t turn often during the year. The quick ratio is defined as cash plus receivables divided by all current liabilities and the target is a ratio of at least 1 to 1. Seasonality will affect your ratio. It’s best to consider this ratio over time (the trend versus a specific point in time).
A club’s operating income and capital income are also critically important. Club income is what we call the net operating income and capital income results combined, excluding depreciation and amortization. But positive club income isn’t enough. To be sufficient, the positive club income should meet or exceed your investment and financing activities each year. If it doesn’t, you face generating cash from other sources such as further borrowings or advances.
It’s important to understand the effect of liquidity on your borrowing capacity, not only for new borrowings, but for existing borrowings. Lenders have metrics they use to gauge your ability to meet whatever they are willing to lend. They start with two metrics in evaluating your capacity to borrow:
- Debt Service Coverage Ratio. This is calculated by dividing annual club income (as defined above) by the principal and interest payments on all outstanding loans and leases. This is a measure of your ability to meet annual debt service obligations. While everything is a negotiation, consider having a minimum ratio greater than 1 to 1 to comply with most bank standards.
- Leverage Ratio. This is outstanding loans and leases divided by your club income. This demonstrates your ability to pay these long-term obligations not just now, but for the life of the obligations. Every bank is different in their underwriting standards as to the leverage they will allow, but the lower the ratio the better.
Liquidity is the lifeblood of any club. Remember, it’s not just what’s in the bank. Understand what claims and demands are present—payroll, payables, debt and capital investment requirements. Monitoring liquidity on an ongoing basis using the above tools will provide you the insight to adjust and better plan for uncertainties, manage changes in your club’s financial condition and forecast cash requirements moving forward.
John Clark is an executive consultant at Club Benchmarking. He can be reached at [email protected].