Eight Ways To Measure The Financial Health Of Your Small Business

Time and again accountants and consultants say that small businesses don’t pay enough attention to cash flow; the measure of how much money you really have in the business. So, how is this a problem and what can you, a business owner or senior manager, do about it?

Judith Dacey, CPA, calls cash-flow statements “probably the most important thing in telling you if your business is on or off target.” To illustrate this point she describes how non-profit board members, not examining their cash-flow statements, hired people and spent money based on their P&L statements. “They didn’t realize that P&Ls were an accrual statement, which basically meant they were basing decisions on promises of payments to come, not money they had in the bank.” The board became aware only when they bounced a check which led to employees being laid off and organization-wide austerity. It could have been avoided if they’d seen the cash-flow statements. A cash-flow statement tells you here’s the cash that has actually come in and that you can work with.

Creating cash flow statements can be a daunting task but a good accounting program such as Quicken can do this without unnecessary accounting expenses. Once you’ve established a way to track cash flow, you can begin to organize and track the financial health of your business. Financial health can also be tracked by paying attention to the following:

• Assets – Tracking your equipment, furniture, real estate and other holdings should be easy. But to have a true idea of the value of your business, you also have to track changes in the value of those assets.

• Liabilities – Liabilities are what you owe but what you owe isn’t always as obvious as totaling your monthly bills. Liabilities include payroll taxes as well as state taxes, social security, Medicare and unemployment taxes.

• Costs of Goods Sold – If you’re buying finished items for resale, calculating the cost of goods sold is relatively easy. However, advertising, marketing, labor, storage and all the overhead and indirect costs not strictly allocated to production. In a manufacturing environment where labor and inventory become major factors.

• Gross Profit Margin – Calculated by dividing gross profit by total sales. If your gross profit is staying consistent or trending upward, you’re on track. On the other hand, a declining margin is an indication that you must either increase prices or reduce costs.

• Debt-to-Asset Ratio? – This ratio lets you know how much of your company is actually owned by someone else like your lender or investors. It can happen as part of a major expansion, or it can also indicate that you’re getting in over your head.

• Value of Accounts Receivable – This is the money you are owed. A rise in accounts receivable may be a warning that your customers are starting to experience financial difficulties.

• Average Receivables Collection Time – This is probably one of the most aggravating pieces of information for cash-strapped businesses, because it tells you how many days you’re acting as ‘banker’ for the people who owe you money.

• Accounts Payable – The flip side of accounts receivable is the accounts payable, what you owe your creditors. An increase in your accounts payable may simply reflect a larger amount of purchases to accommodate a growing business. Unfortunately, an unplanned or unmanaged increase can be an internal warning that your financial strength is waning.

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