Balance sheet, balance sheet, balance sheet — it is what you and your clients should focus on during this time of depressed stock prices, a severe credit crisis and a looming world recession.

With new loans difficult to obtain and businesses facing dropping revenue, a strong balance sheet goes a long way toward keeping a company in business. Plenty of cash on hand has the added benefit of keeping creditors away.

At times like this, then, so-called “defensive” industries have appeal. This encompasses some consumer businesses, telecommunications and utilities. Health care has also entered this edge-of-the-storm category.

In normal times, you can view financial services stocks as another defensive sector; in these abnormal times, even more so. Canadian banks, insurance companies and other financial services institutions have escaped the disaster that has overwhelmed their counterparts in the U.S., Britain, Europe and elsewhere. Therefore, they retain their potential as comparatively safe businesses during a recession — and are worthy of investor scrutiny.

Investment Executive has put defensive sectors and balance sheet strength measurements together in the accompanying table to provide sector-by-sector comparisons.

The primary gauge here is shareholders’ equity, or book value, as a proportion of total assets. This is a simple, straightforward way to estimate relative strength of a company’s balance sheet. A high proportion of equity to assets is good, while a low ratio is not so good.

Note the differing ranges of this ratio: financial services institutions operate on much greater leverage than industrial and utility businesses. So, their ratios — as a rule — are low. And changes in leverage measured in tenths of a percentage point can be significant for these companies.

Although analysts have long favoured the debt/equity ratio to measure balance sheet strength, IE prefers shareholders’ equity/assets. Debt/equity is not applicable across the board, as some companies have no long-term debt. Then, there are problems with companies that have no long-term debt labelled as such on their balance sheets, but which have big amounts of bank debt that look awfully long-term in practice. And how do you take into account miscellaneous liabilities of a long-term nature?

Granted, using book value or shareholders’ equity as a percentage of total assets to measure balance sheet strength has its own question: what’s included in shareholders’ equity? For many companies, goodwill and other intangibles account for a big piece of assets. Do you count them?

Goodwill is a great asset when business conditions are buoyant. In a downturn, it may have no worth. Bloomberg News market columnist Jonathan Weil refers to “that pneumatic, intangible asset known as goodwill, which is about as valuable as the air in a paper sack.”

He elaborates: “While goodwill isn’t completely unsalable, it can’t be sold by itself. It’s just the bookkeeping entry a company records when it pays a premium to buy another.”

For this reason, tangible book value comes to the fore. Standard & Poor’s Corp. research, for example, reports “tangible” book value. This is shareholders’ equity minus goodwill and intangibles.

For some companies, this subtraction makes a big difference. So, both varieties of book value are shown in the table — and each is compared with total assets.

Book value — whether tangible or not — is also a basic, if not rough, guide to a company’s value to investors. As stock prices drop closer to (and perhaps below) book value, shares become less risky and more attractive. The stronger a company is on its fundamentals, the greater the appeal of a low price/book value ratio.

The last two columns relate to cash. Some businesses normally operate without much cash and cash equivalents on hand. Utilities come to mind, as well as financial services companies, whose entire balance sheet is money. Still, it is worth examining how all leading defensive sectors are fixed for ready money.

The table shows the closing cash position per share for each company’s as of its latest quarterly interim report. It also shows how cash positions have changed over the past year.

Some of the percentage changes are big, simply because the amounts of cash are small. But the sprinkling of minus signs in the column that shows the 12-month changes in cash indicate a cash-flow tightening affecting even among these usually safe businesses. IE