Cash flow proves critical for business success, and it becomes even more critical when margins go flat or thin. Everyone does well in good times, but how do you manage cash flows for success in both good times and bad? You can keep your small business running smoothly by focusing on using financial ratios, automating accounting processes and finding ways to get paid faster.
Financial Ratio Analysis for Cash Flow Profitability
Everyone wants to grow, but before preparing for growth tomorrow, you need to know where your stand today. One way to accomplish this comes down measuring and tracking your progress, and successful business owners use financial ratios to track cash flows and profitability over time. The current, profit margin and working capital turnover ratios prove the most common ratios used to track cash flow and profitability. Most banks use these same cash flow and profitability ratios to get a clear picture of your situation before providing small business financing.
Calculate the current ratio by dividing current assets by current liabilities. This shows whether you have enough cash flow on hand to cover your current operating expenses and needs. These expenses include things such as wages, raw materials and inventory. A current ratio above one means you can cover your expenses, but ratios less than one suggest you have a cash flow shortfall. Most companies shoot for a 2 to 1 ratio, but this depends on your business’s industry and niche.
Determine what percentage of sales you keep after paying expenses with the profit margin ratio. Calculate this ratio by dividing net income by total sales. A higher profit margin means you keep a higher percentage of sales, so you naturally want this number to grow higher.
Calculate the working capital turnover ratio by dividing net sales by net working capital. This tells you whether or not you generate enough sales to replenish working capital needs, including inventory and wages, by comparing the money you make in sales with the money used to fund operations. In general, the higher the ratio, the more efficient the business.
Automating Cash Flow Management For Survival
While calculating these ratios for the first time consumes a lot of time, this serves as an important first step in knowing where you stand financially. You can also automate the financial analysis process by investing in accounting automation software. These productivity software options don’t take years to implement, and use can immediately impact your bottom line. Implementing some applications such as Quickbooks only takes a matter of days.
Get Paid Faster
In addition to automating financial ratio calculations, focus on cash flow management by discovering ways to get paid faster. Invoicing immediately increases your likelihood of getting paid fast, and a free invoice generator such as the QuickBooks Invoice Template helps automate this process.
Many organizations fail because they only have one source of cash flow, and when that source dries up, they must borrow funds to survive. This often leads to an over-reliance on debt and a cycle of growing interest payments that eat into future cash flows, potentially making your small business unsustainable. To escape this fate, find ways to fortify your business for sustainability by focusing on financial ratios and account automation. This puts you in a better position to develop additional cash flow streams by automating basic business functions such as bookkeeping, accounting, accounts payable and accounts receivable. From a cash flow and profitability perspective, automating of these functions produces the same effect as exercise on your overall health it adds years to your business life.