Financial health is the heart of every business. It plays a vital role in determining a business’s efficiency and performance. Are you about to establish a new venture? Have you been in the industry for a long time? Whatever the answer is, it is crucial to understand your business’s financial health to determine its continued journey.
Knowing if your business is financially healthy will help safeguard major issues from arising and causing irreparable damage. Bookkeeping can help you know if your business is flat-lining or thriving because it details and updates your accounts and financial information.
Paying your workers monthly salaries is not the only determinant of a successful business. Do you have a steady cash flow? Are you saving any funds? Before we talk about how you can identify if your business is financially healthy, let’s see what a financially healthy business means.
What Is a Financially Healthy Business?
For a business to be financially healthy, it should control and manage its cash flow, profitability, operating efficiency and solvency within acceptable ranges. When you have deep knowledge about financial planning and management practices, your business has a great chance to be financially healthy.
How to Know If Your Business Is Financially Healthy
Sometimes, you get so busy with everyday tasks like making sales and managing customers that you forget to look at the big picture. Everyone wants to gain from their business. One way to do so is to check if the business is financially healthy. Here are tips for knowing the financial health of your company.
Know Your Numbers
Your books should contain information about your revenue, payroll, assets, equity, liabilities, overhead, cost of goods, expenses, and more. Every line item is essential, and you need to know them.
Knowing your numbers is the key to laying a solid foundation for a financially healthy business.
Track Key Financial Ratios
You can use the numbers in your books to gain helpful information about the state of your business health. However, there are also many financial ratios you can use to assess your business health.
Liquidity ratios check the ability of a business to pay its bills when needed. It indicates the ease for businesses to turn their assets into cash. The current and quick ratios are the two common examples of liquidity ratios.
The current ratio compares the total current assets of a company to its total current liabilities. It shows whether a company has enough cash flow to meet its due debts with a safety margin.
To calculate the quick ratio, subtract your stock on hand from your current assets and divide the answer by your current liabilities. The quick ratio determines a business’s ability to meet immediate obligations using its most real liquid assets (quick assets).
Solvency ratios show how your company can repay its debt obligations through sources other than cash flow. The leverage ratio and debt-to-asset ratio helps determine the solvency ratio.
The leverage ratio compares the total liabilities of a business to its equity. A high ratio often makes it difficult for a company to continue borrowing.
Debt to assets is a ratio of the total liabilities to total assets. It indicates the percentage of assets that creditors finance. In many cases, this ratio should not be more than 1.
Profitability ratios not only evaluate the financial health of your business but also compares your business to others within the same industry. Common profitability ratios include gross margin ratio and net margin.
The gross margin ratio compares a business’s gross profit to its total sales. It evaluates the profit a business makes after paying the cost of goods sold.
Net margin is a ratio of a company’s net profit to its total sales. It indicates the percentage of sales revenue left by the company after all expenses have been paid, excluding income taxes.
Management ratios track how well you are managing your working capital. How fast are you in replacing stock? How often do you pay your suppliers? How often do you collect debts outstanding from customers? Management ratios help to answer these questions.
You can compare your management ratios to other businesses within your industry to know how you can improve your business performance. You can use the ATO’s Business performance check tool to check where your company stands among competitors in the same industry.
Balance Sheet Ratios
Common balance sheet ratios include return on investment and return on assets. These ratios will show you how efficient and effective your investment is in the business.
Return on assets shows how well businesses generate profits from the assets applied in the business. The ratio only has meaning when compared to other companies’ ratios in similar industries.
Return on investment (ROI) helps you determine the profitability of your investment. It shows how a business uses its total assets to generate sales.
Stay On Top of Your Billing and Obligations
Create a process for invoicing your customers. Your clients won’t send payments early if you don’t invoice them on time. Be consistent with your billing to quickly receive payments and meet your financial obligations. A weak link can jeopardise the overall chain, and you could pay fees if you make late payments.
Always pay your bills, be it mortgage or rent payments, credit cards, tax payments, payroll, utilities, loan repayment, and vendor bills. Don’t forget that payroll is not just a financial obligation, as many laws govern it too. Pay your employees on time because their lives depend on it. Once you make any payment, record it in your books.
Set Aside Funds for Emergencies
People cannot predict global crises, but they can prepare for them. For instance, no one thought Covid-19 would affect businesses the way it did. The pandemic sent workers home and destroyed the supply chain for businesses that remained open. Issues in the supply chain often increase business costs, and you can cover these expenses with emergency help.
Collecting loans from banks, family members, or friends can take time. You can begin by building at least three months to one year’s expenses. With this, you’ll have funds at hand to handle any emergency that comes. You can use the funds to hire employees or invest in business opportunities. But ensure you use the money only when necessary.
Keep Personal, and Business Expenses Separate
Entrepreneurs often fail to separate their personal and business funds. Remember that knowing your numbers is one of the ways to determine a financially healthy business. But if you mix up your personal and business money, it becomes difficult to monitor.
Keeping a clean record allows you to see your profits and losses without interfering with personal expenses and income. You should set up a business bank account and open a business credit card. Doing this helps you get clean records and shows you where your funds are coming from and where they are going.
A financially healthy business clearly shows where you should invest and where to cut costs based on your immediate financial status. It helps business owners determine various strategies that will help propel their businesses.
During your business’s infancy, try to make good financial decisions right away. When you make positive financial decisions early, you’ll reap the rewards of your efforts fast. Your financial reports are what will guide you into making the right decisions.
Do you have issues getting a clean record and need help in bookkeeping, payroll, or financial reports? Get Started with Visory today.