Understanding the fiscal condition of your business is important when managing daily duties, planning for the long term, and making decisions about opportunities that arise. But that means more than simply knowing what’s in your bank account. To determine your business’s financial fitness, try following the four steps outlined here. The insight you gain could easily give you a leg up on the competition, help you streamline your operations, and quite possibly improve your bottom line.
1. Get Your Records in Order and Establish a Baseline
Record keeping isn’t most small-business owners’ idea of fun, but it’s vital in keeping track of your business’s financial health. Too many people let their income and expense receipts pile up instead of entering them into accounting software. But the reality is that those records provide the baseline of your business’s financial status. If you don’t keep them current, you won’t be able to move on to the next step.
2. Take a Look Back
It’s critical that you understand your company’s financial picture from a rear view. To do this, you’ll generate reports based on the data input you did in the previous step. Here are the best reports to generate and exactly what they will tell you.
- Balance Sheet: Now that your records are organized, you should create a balance sheet, which will give you a quick overview of your company’s financial health up to this point. In it, you’ll list your business’ assets and liabilities. The difference is your current equity in the business.
- Profit and Loss Statement (also known as an income statement): This report compares your monthly income to your monthly expenses, and will show you the amount of profit or loss over a specified amount of time. To get a true picture of where you business has been, you should create a P&L statement for the past 6 to 12 months.
- Three-Month Cash History: Having enough cash on hand is critical to the health of any business, and looking at your cash position every three months can alert you to problems before they become dire. For instance, if you discover that your sales have increased over the past few months, but your available cash has decreased, it may alert you to an accounts receivable issue.
- Overhead Expenses/Sales Ratio: This report is traditionally used to determine what percentage of your revenue is going toward overhead expenses. But you can also use it to look for past negative trends that you can take action to correct. For example, if the report shows that your sales were down but overhead expenses remained the same or increased, it could mean that your business is at risk financially unless you cut your overhead costs.
- Incoming Customer Analysis: A viable business relies not only on repeat business, but new customers as well. Track the source of your sales over the past three to six months to determine where your business is coming from. The answer will inform your marketing strategy. If you don’t have new business, you’ll need to address that in your marketing plan, and if you only have new customers, you’ll need to find out why existing customers aren’t doing repeat business with you.
3. Look Toward the Future
Now that you have a clear picture of where your business has been, it’s time to see where the numbers say you are going. To get a glance into your business’s future, generate these reports:
- >Cash Flow Projection: This report will show you whether or not you’ll have enough cash to cover your operating expenses in the future based on the amount of sales and other cash that the business is expected to receive. You’ll use historical data as well as any other sources of income, such as loan proceeds and owner capital contributions, to prepare it.
- Sales Projections: To get a good idea of your anticipated revenue in the immediate future, create a report that shows you totals for the amount of sales that you’ve closed, but have not yet billed for, and a list of the promising sales that are still in the works.
- Quick Ratio: As the name implies, this formula is a quick method to determine whether or not you have enough cash to pay upcoming expenses. The formula is: cash plus accounts receivable divided by accounts payable or total expenses. You’re doing OK if you have a 1-to-1 ratio, and you’re in even better financial health if your ratio is higher than that.
4. Use All of the Information to Shape Your Business
Knowledge is power, they say, and now that you have the knowledge you need, it’s time to put it to use. Do your reports show that your cash flow is suffering because you have too many overdue accounts receivable? Make a plan to collect them or sell them to a factor. After looking at your projections, do you realize that you may not have enough capital for the expansion you were planning on? Better analyze your marketing plan and figure out how to increase your sales — or reduce your expenses. Maybe you’re selling a good amount of product, but not making enough to pay your expenses. It may be time to think about adjusting your prices.
By taking this holistic approach to looking at your company’s financial heath, you’ll be better able to look at the individual parts and clearly see the past, present, and future financial health of your business.
How much do you know about small business finance and accounting? Take our Financial Literacy Quiz and put yourself to the test!