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Partner's Capital: How Much Is Enough?
As more and more professional services firms struggle to find balance in today's turbulent and recovering economy, some are finding the need to focus more attention on the balance sheet as opposed to relying primarily on the income statement to guide management decisions. While the income statement is often viewed as the most important decision-making document available to the management and ownership of a professional services firm, the balance sheet offers critical insights into a firm's ability to weather tough times with financial strength and endurance.
In the context of this article, partner's capital is defined as the amount of tangible owner's equity on the enterprise balance sheet exclusive of the net equity in accrued receivables and work in process (“ARWIP”). There will be more on this key ARWIP aspect later. Working capital is defined as the net difference between the combined total of operating cash and marketable securities, net of short-term, interest-bearing debt and certain trade payables. Working capital is often calculated and evaluated on an accrual basis of accounting, which would include accounts receivable. Using an income tax/modified cash basis of accounting, receivables and most trade payables are not considered as part of the computation of net working capital. Balance sheet leverage is defined as the proportion of interest-bearing debt in relation to ownership equity. An overleveraged or undercapitalized firm has too much debt and not enough owner's equity. This is the primary focus of this article.
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