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Running a business

How to check the financial health of your small business

Healthy finances are key to small business success. While it can be hard to find the time to make an accurate diagnosis when you’re caught up in the flurry of the day-to-day, it’s critical. With the end of financial year fast approaching, sit down, clear your schedule, and give your books a thorough once-over. If they’re in good shape, great. If they’re under par, it’s time to take action. Follow these five steps to give your business a financial health check.

1. Use financial ratios

How can you tell whether your finances are in good shape if you have nothing to compare them to? This is where financial ratios come in. Work out your own and you’ll be able to judge where you sit now compared to where you were in the past, and against businesses in the same economic sector or the broader market.

Here are a few key ratios:

  • Liquidity: Current assets ÷ current liabilities
  • Solvency: Total liabilities
  • Profitability: Gross profit ÷ total sales
  • Inventory: Average stock x 365 ÷ cost of goods sold (COGS)
  • Return on investment: Net profit before tax x 100 ÷ equity

You should be able to find all these figures in your financial records. If yours aren’t in order, then this in itself is a sign of poor financial health. If that’s the case, then it might be worthwhile considering investing in accounting software such as QuickBooks Online to consolidate your financial information.

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2. Carry out a strategic review

Ideally, you should try to update your business plan monthly or quarterly, taking into consideration what you learned in that time or any changes, and applying them to your long-term strategy. However, if you don’t have enough time to perform such a frequent analysis, then a thorough annual review will do.

This can help you identify any oversights or issues that are negatively impacting your business’s financial health and, armed with this information, change your plan to resolve the issue or improve outcomes. So, take a step back and revisit the basics. Is the current strategy working? Are your business goals and objectives – revenue, profitability, growth – realistic? Have the market or customer needs changed? If so, what new opportunities exist?

3. Take stock of your sales pipeline

Your sales pipeline can tell you a lot about the financial health of your business. How many potential customers are on the list and where are they in the purchasing process? A quick review of this can help you understand which way your future sales are likely to go.

For example, if your pipeline is empty, you could be at risk if you lose some of your current customers or clients. If that’s the case, you’ll need to step up your marketing and sales tactics to bring in new prospects. Conversely, if it’s full, this should indicate future profitability – provided you can close the deal.

4. Go over your cash flow

A small business needs positive cash flow to stay afloat. Not surprisingly, poor cash flow is often cited as one of the top reasons for business failure in Australia. So, if you’re consistently in the negative and struggling to pay the bills each month, it’s a sure sign of trouble. If this is true in your business, you need to rectify it fast. Assess where money is coming in and going out of the business, plan ahead with a cash flow forecast, and apply some cost-saving strategies to help keep cash reserves under control.

5. Review your debts

Borrowing money is part and parcel of running a small business, but if you’ve got too much of the wrong sort of debt, you could be in trouble. If you’ve taken out loans to invest back into the business or expand, and you’re comfortably meeting your repayments, then you’re likely in the clear. But, if your business is operating on debt finance with high interest rates, such as credit cards, for most of your day-to-day expenses, then your finances could take a hit.

If that sounds like your business, you might consider consolidating the debt into a single loan with a lower interest rate and monthly repayments. Taking the financial temperature of your business may not be the most exciting task on your to-do list, but it’s an important one. By identifying any issues, you can quickly work to resolve them and set yourself up for a profitable future.

For more advice on managing your finances, check out these resources.

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