It’s somewhat easy to determine if your company is doing well. You’ll be in the black every month, able to make your payroll and pay all of your monthly bills and expenses. But are there discernible levels or observable distinctions that reliably signify good financial health? Or are there ways to determine how well you’re doing beyond the norm?
There are more than a few ways, some of which may be more appropriate for your business than others. With that in mind, let’s review seven signs that your company is in good financial health.
1. Your Revenue Is Growing
When looking at your profit-and-loss statement, you should be able to see a pretty steady increase in your revenue month over month, year over year. It doesn’t have to be a huge spike in profitability, but even just an increase of a couple percent shows upward movement and a strong financial outlook.
2. Your Expenses Are Staying Flat
In conjunction with your revenue growing, you want your expenses to stay flat. If your business experiences a significant growth spurt, then your expenses may rise, but in general, this increase should be in-line with your increase in revenue. So if your revenue is increasing 3% year over year, you’d want your expenses to increase no more than 3% during the same timeframe.
3. Your Cash Balance Demonstrates Positive Long-Term Growth
While you may be increasing your revenue, if you’re taking that money and simply investing it back into the business, you might find yourself asset rich and cash poor.
A low or stagnant cash balance means your business is not sustainable. You want to keep a healthy amount of cash in the bank so that if anything urgent comes up, you aren’t in a position of having to incur more debt to meet an unexpected expense.
4. Your Debt Ratios Should Be Low
There are two debt ratios to pay particular attention to: a business’ debt-to-asset ratio and its debt-to-equity ratio. Also referred to as solvency ratios, these formulas specifically measure how much your business owes versus how much your business is worth. As with most ratios, a lower number is ideal, and for debt-to-asset ratios, maintaining a 2:1 ratio or lower is preferable.
5. Your Profitability Ratio Is on the Healthy Side
There are a handful of profitability ratios that measure the return on your sales and investments. One of the best ratios to measure is your profit margin. This involves taking your annual net profits and dividing it by your annual sales. So while you may be making sales, your profit margin could still be low depending on your pricing structure, startup costs or other factors. Your profitability ratio is considered healthy when it’s on the high side.
6. Your Activity Ratios Are In-Line
There are a few different activity ratios that measure how your business manages its assets. Three of the most common are:
- Asset Turnover: This formula takes your sales and divides it by your assets. A high turnover ratio translates to more efficient asset management.
- Inventory Turnover: This formula is your cost of sales divided by your average inventory. A high inventory turnover ratio means you’re efficiently managing your inventory.
- Operating Expense Ratio: For this formula, take your operating expenses divided by total revenue. This measures how much you spend in order to generate revenue. In this instance, a lower ratio shows efficiency.
7. You’re Working With New Clients and Repeat Customers
The cost to acquire new clients is higher than the cost to work with the same customers over and over again. A steady stream of new clients and repeat customers demonstrates that your business has multiple options for generating revenue. By having access to new customers, you can help to insulate your business from changing attitudes and buying patterns.
Measuring the health of your business’ finances can be as simple as reviewing a profit-and-loss statement or as complicated as analyzing all the different elements of your business. However, there is very little doubt that fully understanding your business’ finances is a sure way to remain successful and profitable.
Information may be abridged and therefore incomplete. This document/information does not constitute, and should not be considered a substitute for, legal or financial advice. Each financial situation is different, the advice provided is intended to be general. Please contact your financial or legal advisors for information specific to your situation.
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