As a small business owner, you have probably had many moments that left you wondering if your business is on the right track. You may feel concerned when you are paying bills and notice things were getting a little tight in your business account. It is very common for business owners to wonder, “is my small business okay?” Healthy finances are key to small business success. While it can be hard to find the time to make an accurate diagnosis when you’re caught up in the flurry of the day-to-day, it’s critical.
With the year flying by, it is essential to sit down, clear your schedule, and give your books a thorough once-over. If they’re in good shape, great. If they’re under par, it’s time to take action and hire outsourced accounting services for some further assistance. Here are seven things to review to ensure your company is in great financial health.
Take a look at your profit-and-loss statement to evaluate your revenue. You should be able to see a pretty steady increase in your revenue month over month and year over year. It doesn’t have to indicate major growth and increase in revenue, but you should see just an increase of a couple of percents which indicates upward movement and a strong financial outlook.
2. Flat Expenses
In addition to growing revenue, you want your expenses to remain flat. If your small business experiences major growth, it is likely your expenses will rise, but in general, 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. If you are unsure about how to navigate your business’s growth stage, we highly recommend hiring outsourced accounting services.
3. Healthy Profitability Ratio
Profitability ratios are a class of financial metrics that are used to assess a business’s ability to generate earnings relative to its revenue, operating costs, balance sheet assets, and shareholders’ equity over time, using data from a specific point in time.
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. Profit margin is one of the commonly used profitability ratios to gauge the profitability of business activity. According to Investopedia, it represents how much percentage of sales has turned into profits. Simply put, the percentage figure indicates how many cents of profit the business has generated for each dollar of sale.
While your company 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. If you are experiencing a low-profit-margin, consult with your local CPA to see what your small business can do to increase it.
4. Low Debt Ratios
A company’s debt ratio is the ratio of total debt to total assets. Total debt includes both short-term and long-term debt. There are several debt ratios, which give users a general idea of the company’s overall debt load as well as its mix of equity and debt. There are two debt ratios to pay particular attention to:
- debt-to-equity ratio- The debt-to-equity ratio is a financial ratio indicating the relative proportion of shareholders’ equity and debt used to finance a company’s assets. Closely related to leveraging, the ratio is also known as risk, gearing or leverage. The debt-to-equity (D/E) ratio is calculated by dividing a company’s total liabilities by its shareholder equity. These numbers are available on the balance sheet of a company’s financial statements.
- debt-to-asset ratio- Total liabilities divided by total assets or the debt/asset ratio shows the proportion of a company’s assets which are financed through debt. If the ratio is less than 0.5, most of the company’s assets are financed through equity. If the ratio is greater than 0.5, most of the company’s assets are financed through debt. Investors use the ratio not only to evaluate whether the company has enough funds to meet its current debt obligations but also to assess whether the company can pay a return on their investment.
Debt ratios can be used to determine the overall level of financial risk a company and its shareholders face. In general, the greater the amount of debt held by a company, the greater the potential level of financial risk the company could face, including bankruptcy.
5. Positive Cash Flow
Poor cash management is probably the most frequent stumbling block for entrepreneurs. By generating enough cash, a business can meet its everyday business needs and avoid taking on debt. That way, the business has more control over its activities. Even if a company is making a profit, by making more revenue than it incurs in expenses, it will have to manage its cash flow correctly to be successful.
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.
6. In-Line Activity Ratios
Activity ratios are a category of financial ratios that measure a firm’s ability to convert different accounts within its balance sheets into cash or sales. They measure the relative efficiency of a firm based on its use of its assets, leverage, or other similar balance sheet items and are important in determining whether a company’s management is doing a good enough job of generating revenues and cash from its resources. Some of the most common activity ratios include:
- Inventory Turnover- inventory turnover ratio measures how often the inventory balance is sold during an accounting period. The cost of goods sold is divided by the average inventory for a specific period. Higher calculations indicate inventory is quickly converted into sales and cash.
- Asset Turnover- assets turnover ratio measures how efficiently an entity uses its assets to make a sale. Total sales are divided by total assets to see how proficient a business is in using its assets. Smaller ratios may indicate that the company is holding higher levels of inventory instead of selling.
- Accounts Receivable Turnover Ratio- The accounts receivable turnover ratio determines an entity’s ability to collect money from its customers. Total credit sales are divided by the average accounts receivable balance for a specific period. This activity ratio calculates the management’s ability to receive cash. A low ratio suggests a deficiency in the collection process.
7. New Clients and Repeat Customers
It can cost five times more to attract a new customer than it does to retain an existing one. In order to grow, every company needs to acquire new customers and sustain the ones they have. Having a steady stream of returning customers as well as new clients demonstrates that your small business has multiple options for generating revenue. Companies need to develop processes that attract, convert and retain customers if they are to be successful in the long run.
Limitless Investment & Capital’s Outsourced Accounting Services
Although business growth is a sign of success, successfully navigating the growth stages of your business can be extremely challenging. Outsourced accounting services that include the expertise of a CFO can help you anticipate cash flow shortages, fluctuating costs and measure customer acquisition costs against a customer’s lifetime value to handle the kinds of growing pains all successful businesses experience. Limitless Investment and Capital’s outsourced accounting services can include access to a free financial controller to ensure your small business successfully navigates its growth stage. Get in touch today to learn more about our unlimited transaction bookkeeping package + access to a free financial controller!