It’s easy for small business owners to get bogged down with day-to-day operations — there’s probably no shortage of urgent tasks that need your attention. As a result, setting aside time to check on your business’s financial health might get pushed to the back burner.
The truth is that running a smooth business and tending to its financial health are equally important. If you’re having trouble juggling both, consider these five strategies you can use to measure the financial well-being of your business.
1. Do a cash flow analysis
According to QuickBooks data, 61% of small businesses that have been operating for less than five years have a cash flow problem. Doing a cash flow analysis can show you if your business has enough income to cover all of its expenses — or if it’s running in the red. Here’s how to do it:
- Choose a time period to focus on: That might be a month, a quarter, or a year.
- Identify your income sources: That includes revenue coming in from products or services your business provides, as well as investment gains. Gross income is the total amount your business earns in a given time period. Net income is different and represents your business's "take-home" income after deducting taxes and expenses.
- Get clear on your expenses: This is any money that’s flowing out of your business. It can include accounts payable, operating expenses, debt payments, taxes, and other liabilities.
- Turn this data into a cash flow statement: A cash flow statement typically focuses on operating income activities, which is your income minus your expenses. If this number is positive, then your business has positive cash flow. Your statement should also look at your business’s financing activities, as well as money related to investing in assets.
- Put it all together: When reviewing your cash flow statement, do you notice any patterns? Perhaps you have negative cash flow, or see that debt or investments are eating into more of your income than you'd like. Seeing it all in black and white can help you identify your financial priorities.
2. Conduct a financial ratio analysis
Net income and gross revenue are important metrics, but they don’t tell the whole story. Reviewing important financial ratios can bring things into focus. Here are a few key financial ratios to understand, according to FreshBooks:
- Cash flow to debt: This represents how much of your current cash flow is going toward debt repayment. It’s calculated by adding your net income and depreciation, then dividing your total debt. If that number is less than one, it may indicate that you’re struggling to pay all your business expenses.
- Net profit margin: Start with your gross income. After deducting all your expenses, taxes, and interest, the percentage that’s left over is your net profit margin. It’s calculated by subtracting your total expenses from your total revenue, then dividing that number by your total revenue. The higher your net profit margin, the better.
- Gross margin ratio: This represents how much money you have left after paying for products your business sells. Take your sales and subtract the cost of your goods. Then divide that number by total sales. A lower gross margin ratio may suggest that you’re having trouble covering your business expenses.
3. Measure your business’s liquidity
When it comes to your business’s financial health, liquidity is important. Do you have enough business assets to cover all your liabilities? That’s where your business’s quick ratio comes in — it provides a snapshot of your business’s liquidity. The accounting software platform Xero suggests focusing on assets you could quickly convert to cash if needed. Divide these liquid assets by your business’s current liabilities to find your quick ratio. Ideally, you’ll have more liquid assets than debts.
4. Reevaluate your debt
As a business owner, you want to strike a balance between investing in your company and staying on top of daily operations. If you overextend yourself, you may have trouble covering all your expenses. Begin by evaluating all of your business debt. Now look at your monthly payments, interest rates, and fees. How much is your debt costing you each month?
If it’s affecting your cash flow, you might consider restructuring your balances through debt consolidation. This is when you take out a new business loan, then use that to absorb your outstanding debts. It could help you secure a lower interest rate and one monthly payment going forward.
5. Reassess your financial goals
What does a financially successful business mean to you? You might measure that in one or more of the following ways:
- Gross revenue
- Net income
- Employee retention and happiness
- Your social responsibility impact
- Positive customer reviews
- Your personal take-home pay
- The level of satisfaction and joy your business provides you
You may find that your business’s financial health is on track, but you’re not hitting targets that are personally important to you, like employee wellness or supporting your local community. The opposite may also be true. Either way, taking your business’s financial temperature can give you insight to realign your priorities.
