The SPACE or Strategic Positioning matrix assesses a business along four dimensions to find an appropriate strategic thrust and in this article, we’ll look at the SPACE factors for financial strength.
Financial Strength In The SPACE Matrix
According to the creators of the Strategic Position and Action Evaluation Matrix, (Strategic Management – A Methodical Approach”, Rowe, Mason, Dickel, Mann and Mockler. Published by Addison Wesley) the following items should be considered when assessing Financial Strength:
- Return on investment (low to high)
- Leverage (debt to equity ratio) (inbalanced to balanced)
- Liquidity (access to quick money when needed) (inbalanced to solid)
- Capital required versus capital available) (high to low)
- Cash flow (low to high)
- Ease of exit from market (difficult to easy)
- Risk involved in the business (much to little)
- Inventory turnover (slow to fast)
- Use of economies of scale and experience (low to high)
The factors for Financial Strength are marked from 1 to 6 and a high score is good, a low score indicates financial weakness.
Interpreting Financial Strength In The SPACE Matrix To Your Situation
This is the most generic of the dimensions in the SPACE matrix. High profit margins and access to cash to invest when you want it are valuable in any business.
Several of the financial measures are not black and white:
- Leverage ranges from imbalanced (bad) to balanced (good) on the basis that equity finance is more expensive than moderate levels of debt so the business should aim for the lowest weighted average cost of capital. Finance theory is beyond the scope of this blog so I won’t go into details. In my accountancy training I was taught that a debt to equity ratio of around 1:1 was good but it is much more dangerous to be highly geared (high debt to equity) than under. Over the last twenty years many private equity deals have been done on the basis of high debt ratios and while the credit crunch has made access to funding difficult, the record low interest rates have prevented many bankruptcies.
- Liquidity also ranges from imbalanced (bad) to balanced (good) because high levels of cash will depress returns on investment while liquidity problems will mean the business struggles to pay creditors as they fall due and may mean the business is technically insolvent. Going back to my days as an accountancy trainee, a current ratio of 2:1 (current assets to current liabilities) and a quick ratio of 1:1 (debtors plus cash/creditors) was considered good.
Businesses have different financial needs in terms of:
- asset intensity – some businesses need large investments in capital equipment
- working capital cycles – a supermarket will be paid in cash by customers well before it has to pay its suppliers while a distributor may have to hold high levels of stocks/inventories, finance trade debtors and even pay for imported goods before they are despatched.
The Impact On Strategic Direction For Different Levels Of Financial Strength
A strong score on financial strength backed up with reasonable environmental stability suggests that either an aggressive strategy or conservative strategy is appropriate depending on the position for competitive advantage and industry attractiveness.