As a business owner, your company’s financial health is one of the most important priority focus areas you’ll need to keep in check. It’s important to review the efficiency of your business and detect possible cash leaks arising from situations that could result in declining profits for your business. However, there is more to checking your financial stability than just looking at your bank balance.
Take a look at this 5 step review on how to recognise and remedy your company’s poor financial management:
1. Check the Company’s Current Liquidity: There are two good tests to perform to test the current solvency of your business. One formula to use during the test is taking the total amount of cash you have in the bank and dividing it by your monthly expenses. Once calculated, the results will show the total number of months your company should be able to operate for if your sales figures were to reduce or if your clients stopped paying their invoices. The larger the number, the longer your business will stay in operation. A good rule of thumb is to have at least cover for 3 months of expense.
The other is known as the quick ratio. Take your cash and debtors and divide by your current liabilities (trade creditors + taxes owed). A number less than one is a warning of financial distress, whereas a figure >2 is a healthier place to be.
2. Keep an Eye on the Net Profit Margin: As your business revenue continues to grow, there is the chance of losing sight of your original KPI’s, which you initially set in place when you first started up. One of the key areas to focus on is profit margin. As your company starts to sell more products and services, hire more staff and spend more time with clients, your net profit margin assumptions will begin to change. You’ll need to ensure your net profit margin is more than sufficient to pay interest, invest in capital and pay a return to shareholders/directors.
- To calculate your company’s net profit margin, take your net profit after all costs and divide it by your total revenue. The larger the net profit margin, the better the outcome will be for your business financially. Healthy businesses often have net profit margins >10%
3. 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: debt to equity and debt to assets ratio.
- The debt to equity ratio shows the proportion of equity and debt a company is using to finance its assets and the extent to which shareholder’s equity can fulfill obligations to creditors in the event of a business decline.
- The debt to assets ratio indicates the proportion of a company’s assets that are being financed with debt, rather than equity. The ratio is used to determine the financial risk of a business.
It’s tough to distinguish what acceptable ratios are, as with most ratios, the lower they are usually the better, so long as you are generating enough cash and profit to repay capital and interest, then your ratio will improve over time.
4. Review Your Accounts Receivable: If your company is encountering cash flow problems, you might want to conduct an audit on your accounts receivable. If you have clients who are continuously late in paying their bills, this could be severely impacting your bottom line. The best way to rectify this is to have robust credit management & control policies which might include putting customers on stop or charging interest on overdue client accounts. It would be best to speak with the client first, to help bring them up to speed on your payment terms and conditions.
5. Assess the Sales Pipeline: Keeping track of your current sales leads, as well as the status of your sales pipeline, is a good indicator to help diagnose whether or not your company is in a competent financial position. A pipeline full of cold and/or warm leads or those that are in the early sales process indicate that you may not have enough business to sustain you throughout the rest of the year or further into the future.
Find out if your business is showing signs of poor financial management by taking our free financial management healthcheck. You’ll get a quick spot check and receive your results via email. As a follow up, one of our experienced EFM Experts will get in touch to discuss the opportunity of a one to one consultation. Click here to get in touch today.