As a business owner, your company’s financial health is of the utmost importance. There is more to measuring your financial health, however, than simply looking at how much money is in the bank. Let’s review seven different ways to track your business’ finances so you can recognize and remedy poor financial health.
1. Measure Your Debt Levels
As with your personal finances, there is a tipping point for your business between acceptable and unacceptable debt. There are two specific ratios to measure: the debt-to-equity ratio and the debt-to-assets ratio.
- Debt-to-Equity Ratio: You’ll need to know how much debt your company owes and how much equity you have; divide your debt by your equity, and you have your debt-to-equity ratio. For example, if you owe $100,000 in debt and have $25,000 in equity, your ratio is 4:1.
- Debt-to-Assets Ratio: Similar to the previous ratio, you’ll need to know how much debt you owe and how much you own in assets. You would again divide your total debt by your total asset amount. For example, if you owe $100,000 in debt and have $50,000 in assets, your ratio is 2:1.
It’s hard to say what acceptable ratios are; as with most ratios, the lower the better. The quickest way to increase your ratio is to pay down your debt and avoid incurring any more.
2. Review Accounts Receivable
If you’re encountering cash flow problems or are feeling the pinch when trying to make ends meet, you might want to conduct an audit on your accounts receivable. If you have clients who are perpetually late in paying their bills—in excess of 60, 90 or 120 days—this could be severely impacting your bottom line.
One of the best ways to counteract this is to start charging interest on overdue accounts. It’s best to speak with the clients first as well, to bring them up to speed on your payment terms and expectations.
3. Check Your Current Capital
Another formula to use is one that tests your business’ current solvency. Simply put, this is the amount of cash you have in the bank divided by your monthly expenses. The number you end up with is the number of months your company should be able to operate if your sales slowed or if your clients stopped paying their invoices.
Obviously, the larger the number, the longer you can stay in business if you encounter adversity. If your sales cycle is generally on the short side (e.g. three to six months), having six to twelve months of operating costs in the bank is acceptable. However, if your sales cycle is longer, you’d want to increase the number.
4. Review Your Company’s Current Cash Ratio
Similar to checking your company’s financial solvency, you’ll also want to do an assessment of your current ratio. This involves taking the total number of assets you have (whether liquid, cash or otherwise) and dividing it by your total number of liabilities. The goal is to have a current ratio that falls between 1.5 and 3.
5. Take Stock of Your Sales Pipeline
Knowing how many leads you currently have in your pipeline—as well as the status of these leads—is a great indicator of a business’ poor or good financial health. A pipeline of mostly cold leads or warm leads or those that are early in the sales process indicate that, a few months down the line, you may not have enough business to sustain you throughout the rest of the year or further into the future.
6. Keep an Eye on Your Profit Margin
As your business and revenue grows, it’s easy to lose sight of the key performance indicators you initially built your business upon. One of these is profit margin. As you sell more goods or services, spend more time with clients and hire more employees, your profit margin assumptions will change. The most important profit margin formula for the overall state of your business is net profit margin.
Net profit margin measures your bottom line. First, you calculate your net profit, which is your total revenue minus your total costs. Then, take your net profit and divide it by your total revenue. This figure is your net profit margin, and the bigger it is, the better.
7. Look Forward, Not Just Backward
While reviewing your financial statements is the easiest way to see what your financial status is, it’s also a fairly reactive measurement. Financial statements measure results; they are not predictive of future success or very forward-thinking. Examine your operational metrics, such as marketing, advertising, production and human resources, to more accurately address and adjust your strategy going forward.
Keeping your business healthy and viable might seem like an overwhelming task. But by staying up-to-date on a few key financial indicators, however, you can easily track your business and avoid fiscal pitfalls.