A financial checkup for your business starts with an examination of the last 3 years annual financial statements. Three years will reveal trends in the business activity in such areas as liquidity, leverage and profitability. If you are borrowing money from your bank, you may not know it but your banker is performing this checkup every year, so maybe you should too before he tells you the business trends are not looking good.
Ratios Are Important
Ratio analysis is one tool used by bankers, investors and savvy business managers. Knowing which ratios are important, and why they are important, is key. A few of the more important ratios are the current ratio, the debt to equity ratio, and profitability ratios.
The Current Ratio is the number one ratio used to determine your company's ability to pay its bills. To get the ratio, you divide the current assets number from your balance sheet by the current liabilities. If the ratio is less than 1, you have problems. The best performing companies often have a ratio of 3 or higher.
The Debt to Equity Ratio is a measurement of leverage that reveals how much of the company is financed by its owners and how much is financed by debt. Companies with lower debt to equity ratios are less risky than those with higher debt to equity ratios.
The most frequently used ratio is the Profitability Ratio because it determines the company's bottom line and reveals efficiency and overall performance. There are a number of profitability ratios that are commonly used, such as Gross Profit Margin, Operating Profit Margin, and Net Profit Margin. The key is to look at the trend - are your margins increasing, decreasing, or remaining constant. Not only that, you should look at how those margins compare to other companies in the same industry as yours.
Another ratio I always look at is Days' Sales Outstanding. This is a measurement of how quickly you are collecting your accounts receivable. Obviously the lower number here the better. Again, it is important to look at the trend to determine if this measurement is increasing or decreasing.
Other Factors to Consider
The financial checkup doesn't end with a ratio analysis. There are also a number of other questions to be answered to get a better picture of your company health. For instance:
- Are your company's revenues tied to one key customer?
- Are your company's revenues tied to one key product?
- Does your company rely on a single supplier?
- What percentage of the company's business is generated in a small market segment?
- What competition do you currently have and are there new ones to potentially face in the future?
- What are the company's future prospects?
- What will happen in the legal and regulatory environment of your business?
It's very possible an independent outsider such as Performance Advisors may best be able to give more objective answers to those questions and recognize threats that the business owner may not see.
Tips
If your financial checkup revealed problems, here are some tips that may help:
- Deal with any problem areas immediately
- Let your budget and your business plan be your roadmap
- Make it a point to review your financial performance regularly
- Carefully examine your capital purchases
- Restructure debt if possible
- Keep insurance coverage up to date
One ratio at a single point in time may give you insight, but the real power comes from compiling the data over long periods of time on a regular basis. Let Performance Advisors assist you with a business checkup today.
Visit the Performance Advisors website for articles such as Benchmarking -A Key Indicator of Business Financial Health, Better Benchmarking, How To Tell If Your Business Is Healthy, Tips To Get Your Business In Top Financial Shape, Why Isn't My Company Profitable, and others that can help you determine your business financial health. Of course Performance Advisors is here to help you if you need assistance. Call us at 602-579-5725 or email Performance Advisors today.
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