Bankrupt In 48 Hours: 3 Powerful Lessons From the Collapse of Silicon Valley Bank
Last week, Silicon Valley Bank went from respectable to bankrupt in less than two days.
Here is a graph of the bank's profits for 2019 to 2022:
Those numbers are billions, not millions. That's right - Silicon Valley Bank earned a profit of more than 1.5 billion dollars last year.
What went wrong?
On the surface it was a classic "run on the bank." People lost faith in SVB and pulled their deposits. The banks labored breathing quickly became a death gasp. It was over in a matter of hours.
Why did people lose faith?
That answer is a lot more complicated. If you like geeking out on technical details, this post on LinkedIn explains it beautifully.
For everyone else, here are 3 takeaways from SVB's collapse that apply to virtually any business.
Point 1: The balance sheet is what matters.
As an astute reader of this newsletter, you know this is one of my major hobby horses. The collapse of SVB injected that horse with steroids!
Even though SVB averaged nearly $4 million in profit every day, the balance sheet had growing cracks.
What were the cracks?
Essentially banks own inventory kind of like a store. It's an inventory of loans, instead of soup cans.
SVB's "soup cans" were declining in value due to rising interest rates. This was apparently noted on their December balance sheet. It was just a note - the value of the loan inventory wasn't actually written down.
Unfortunately, SVB ran low on cash and had to sell its "soup cans." The loans fetched the discounted prices, not the higher values they had on their balance sheet. The losses suddenly became real, investors panicked, and the rest is history.
Profits are meaningless when the balance sheet is flawed.
As a quick stress test for your own company, crack open the balance sheet and analyze every line. If any of the values look off, make it a priority to get them fixed.
Common problem areas on a balance sheet:
Accounts receivable. Uncollectable amounts not written off.
Inventory. Obsolete or devalued items not written down.
Loans. Principal/interest not properly recorded, leading to incorrect loan balances.
Point 2: The most important balance sheet metric is working capital.
With an accurate balance sheet, the next step is analyzing it. One of the first things I look at is working capital. Virtually all troubled companies have low working capital.
Working capital = Total Current Assets - Total Current Liabilities
In this balance sheet from Bob's Alligator Farm:
Working capital = $19,848 - $18,988 = $860
The ratio (current ratio) = $19,848/$18,988 = 1.05
In short, this means if Bob turns all his current assets into cash (i.e. collects all his receivables) and pays off all his payables, he will have $860 left.
That is a dangerously thin amount of working capital. Healthy companies have 2X or more current assets compared to current liabilities. Bob's farm should have $35,000 of current assets.
Ideally, cash should be a sizable portion of total current assets. If a company needs to sell inventory or collect receivables to pay it's bills, the situation is much more shaky.
That was SVB's situation.
Point 3: The 2nd most important balance sheet "metric" is total equity.
Equity isn't really a metric. It's just an amount. On the above balance sheet, equity is $10,860. The liabilities (or debts) are $18,988.
What that means is that of the $29,848 in assets, $18,988 (or 64%) are owned by creditors and $10,860 (or 36%) are owned by Bob.
Equity is gas in the tank. As equity nears $0, or becomes a very low % of overall assets, the company is generally headed for catastrophe.
Apparently that is what happened to SVB. Per the aforementioned LinkedIn post, the balance sheet showed $12 billion in equity as of December.
Unfortunately, the value of their loan inventory had already declined by more than $12 billion. With that write off factored in, they had run out of gas a couple months ago. They were hoping they could wait it out until their loans increased in value, but it didn't work.
IMPORTANT NOTE: For most small business owners, personal equity is more critical than business equity. It's common for small (and even large) business owners to take all the profits out of their business.
That is fine, as long as the owner has personal equity to put back into the company, if necessary.
False Simplicity Alert
It can be tempting to read an article like this and say, "That's obvious."
Except it isn't. If your small business has a reliable, accurate balance sheet, I'd say you are in the top 5% of all small businesses.
Which means roughly 95% of small companies don't know how much working capital or equity they really have.
After all, if even sophisticated investors at a $200B+ bank didn't see collapse coming, balance sheet clarity is a skill almost everyone can hone.
TLDR:
The balance sheet is what matters.
The most important balance sheet metric is working capital.
The 2nd most important balance sheet "metric" is total equity.
Be Your Own
Bankrupt In 48 Hours: 3 Powerful Lessons From the Collapse of Silicon Valley Bank
Last week, Silicon Valley Bank went from respectable to bankrupt in less than two days.
Here is a graph of the bank's profits for 2019 to 2022:
Those numbers are billions, not millions. That's right - Silicon Valley Bank earned a profit of more than 1.5 billion dollars last year.
What went wrong?
On the surface it was a classic "run on the bank." People lost faith in SVB and pulled their deposits. The banks labored breathing quickly became a death gasp. It was over in a matter of hours.
Why did people lose faith?
That answer is a lot more complicated. If you like geeking out on technical details, this post on LinkedIn explains it beautifully.
For everyone else, here are 3 takeaways from SVB's collapse that apply to virtually any business.
Point 1: The balance sheet is what matters.
As an astute reader of this newsletter, you know this is one of my major hobby horses. The collapse of SVB injected that horse with steroids!
Even though SVB averaged nearly $4 million in profit every day, the balance sheet had growing cracks.
What were the cracks?
Essentially banks own inventory kind of like a store. It's an inventory of loans, instead of soup cans.
SVB's "soup cans" were declining in value due to rising interest rates. This was apparently noted on their December balance sheet. It was just a note - the value of the loan inventory wasn't actually written down.
Unfortunately, SVB ran low on cash and had to sell its "soup cans." The loans fetched the discounted prices, not the higher values they had on their balance sheet. The losses suddenly became real, investors panicked, and the rest is history.
Profits are meaningless when the balance sheet is flawed.
As a quick stress test for your own company, crack open the balance sheet and analyze every line. If any of the values look off, make it a priority to get them fixed.
Common problem areas on a balance sheet:
Accounts receivable. Uncollectable amounts not written off.
Inventory. Obsolete or devalued items not written down.
Loans. Principal/interest not properly recorded, leading to incorrect loan balances.
Point 2: The most important balance sheet metric is working capital.
With an accurate balance sheet, the next step is analyzing it. One of the first things I look at is working capital. Virtually all troubled companies have low working capital.
Working capital = Total Current Assets - Total Current Liabilities
In this balance sheet from Bob's Alligator Farm:
Working capital = $19,848 - $18,988 = $860
The ratio (current ratio) = $19,848/$18,988 = 1.05
In short, this means if Bob turns all his current assets into cash (i.e. collects all his receivables) and pays off all his payables, he will have $860 left.
That is a dangerously thin amount of working capital. Healthy companies have 2X or more current assets compared to current liabilities. Bob's farm should have $35,000 of current assets.
Ideally, cash should be a sizable portion of total current assets. If a company needs to sell inventory or collect receivables to pay it's bills, the situation is much more shaky.
That was SVB's situation.
Point 3: The 2nd most important balance sheet "metric" is total equity.
Equity isn't really a metric. It's just an amount. On the above balance sheet, equity is $10,860. The liabilities (or debts) are $18,988.
What that means is that of the $29,848 in assets, $18,988 (or 64%) are owned by creditors and $10,860 (or 36%) are owned by Bob.
Equity is gas in the tank. As equity nears $0, or becomes a very low % of overall assets, the company is generally headed for catastrophe.
Apparently that is what happened to SVB. Per the aforementioned LinkedIn post, the balance sheet showed $12 billion in equity as of December.
Unfortunately, the value of their loan inventory had already declined by more than $12 billion. With that write off factored in, they had run out of gas a couple months ago. They were hoping they could wait it out until their loans increased in value, but it didn't work.
IMPORTANT NOTE: For most small business owners, personal equity is more critical than business equity. It's common for small (and even large) business owners to take all the profits out of their business.
That is fine, as long as the owner has personal equity to put back into the company, if necessary.
False Simplicity Alert
It can be tempting to read an article like this and say, "That's obvious."
Except it isn't. If your small business has a reliable, accurate balance sheet, I'd say you are in the top 5% of all small businesses.
Which means roughly 95% of small companies don't know how much working capital or equity they really have.
After all, if even sophisticated investors at a $200B+ bank didn't see collapse coming, balance sheet clarity is a skill almost everyone can hone.
TLDR:
The balance sheet is what matters.
The most important balance sheet metric is working capital.
The 2nd most important balance sheet "metric" is total equity.
Scott Hoover, CPA
About The Author:
Scott lives in Wisconsin with his wife Priscilla and their active family of eight children.
He has worked as a CPA and part-time CFO for over a decade, and draws on this experience to provide practical, down-to-earth guidance to his clients.
In addition to his CPA day job, he and his family have a small farm where they raise calves and produce. In his "spare" time, Scott enjoys writing articles on finance and faith.
Send any comments or feedback directly to scott@beyourowncfo.com.
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