A Guide to Viability | Help & Support | Bank of Scotland Business
Viable, productive enterprises that consistently generate strong earnings provide jobs and pay taxes –they help Britain prosper. This simple guide seeks to support an understanding of financial viability; we hope it will prove useful in discussions with advisers and influence business thinking, in particular in situations where a business is experiencing a challenging financial environment.
So what is Viability?
Viability is a commercial judgement of the ability of a business to meet ongoing financial obligations, with an additional margin of comfort to support future investment and trading.
Viability starts with Earnings, however there are other aspects to consider including Cash Flow, Net Worth and Balance Sheet Strength, Financial Projections, Financial Trends and Non-Financial Factors. Finally having a trusted Financial Support Team around you is valuable. We explore each of those areas below.
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EBITDA is a commonly used measure of earnings or underlying profit. It is calculated by adding back depreciation, amortisation and interest to the net profit, to which we then deduct dividends or drawings when assessing viability.
If your EBITDA exceeds the demands on earnings consistently over a number of trading years, then that is an indicator of viability. EBITDA is not the sole measure and has its limitations but it is a good start in the evaluation process.
There are variations on how EBITDA can be calculated, but for simplicity an example EBITDA calculation is:
Items/Amounts
Year 3
Year 2
Year 1
Items/Amounts
Net profit before tax
Year 3
200
Year 2
300
Year 1
400
Items/Amounts
+ Depreciation and amortisation
Year 3
100
Year 2
100
Year 1
100
Items/Amounts
+ Interest
Year 3
60
Year 2
50
Year 1
50
Items/Amounts
- Drawings / Dividends
Year 3
250
Year 2
225
Year 1
225
Items/Amounts
(A) Adjusted Profit “EBITDA”
Year 3
110
Year 2
225
Year 1
325
In this example over three years the EBITDA has reduced. We then need to consider the demand on the business’s earnings such as loan payments, interest, and hire purchase payments.
Item/Year
Year 3
Year 2
Year 1
Item/Year
Interest
Year 3
60
Year 2
50
Year 1
50
Item/Year
Bank capital repayments
Year 3
100
Year 2
100
Year 1
100
Item/Year
HP and Other Loan capital repayments
Year 3
75
Year 2
75
Year 1
75
Item/Year
(B) Debt to be serviced
Year 3
235
Year 2
225
Year 1
225
Surplus or Shortfall
(A) - (B)
-125
0
100
In this example the business's EBITDA is in decline, yet the demands on its earnings remain significant. In Year 3 there is a material shortfall.
Whist this calculation offers a guide to viability, please be aware it does not include net movements in working capital (stock / debtors / creditors), tax paid or business investment such as capital expenditure not funded on HP.
Rather than focussing on EBITDA, a more complete picture can be formed by calculating the Cash Flow available for Debt Service (CFADS) which means your EBITDA plus or minus net movements in working capital, less tax paid and capital expenditure paid (net of capital expenditure funded by asset disposals and/or hire purchase and/or finance leasing).
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Whether a business has sufficient capital to meet all its obligations as they fall due is a key test of solvency and centres on the cash flow (sometimes called liquidity). Forecasting cash flow over a 13 week period and again projecting over a 12 month period using reasonable assumptions can help management answer that test.
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If a business's assets exceed its liabilities it can be said to be balance sheet solvent. In simple terms, if the Net Worth is increasing then that is a positive sign, if it is in decline then the business may be surviving by living off capital, which cannot continue indefinitely. However if the balance sheet is strong, it can shield a business from a downturn for some time, giving the owners the time to implement a turnaround strategy.
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Forward looking statements, such as projections, prepared on an integrated profit and loss, balance sheet and operating cash flow basis can, when using reasonable assumptions, support the understanding of the impact of decisions you can take within your control (such as capital expenditure or gross margin adjustment) and the impact of risk factors outside your control, such as an increase in a key cost.
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The trend of your Earnings, Cash Flow and Net Worth over a period of years will influence a lender or credit agency in their assessment of whether your business is consistently viable and that can have an impact on the credit terms you receive from your suppliers.
However a third party’s judgement on viability is not just measured by financial trends, but is supplemented by a commercial judgement of the economic outlook, sector you are in, risks applicable to your business, management actions and experience.
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Your business may have an in-house Finance Director or Manager or may rely on support from accountants or advisers. Whatever form that takes your Financial Support Team should have access to the information which can then be used to build the financial picture of your business. Specialist advice may sometimes be necessary when a business is either undergoing a period of change or is facing challenging conditions.
We will work with you and your Financial Support Team to review your funding and financial structure.
Disclaimer
While all reasonable care has been taken to ensure that the information provided is correct, no liability is accepted by Bank of Scotland for any loss or damage caused to any person relying on any statement or omission. This is for information only and should not be relied upon as offering advice for any set of circumstances, including in connection with any existing facility or application for finance. Specific advice should always be sought in each instance.