McDermott Financial Solutions | 4 Ways to Measure the Health of Your Business
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4 Ways to Measure the Health of Your Business

Last week we talked about working on the business. Moving your business ahead may require that you step back to gain a healthy perspective. Delegating tasks to others who are equally or more talented at accomplishing them will free up your time to working on marketing, new business opportunities or maybe even a company acquisition.

However, to work on the business, you need a baseline that tells you where you are today and then you can dream about where you’d like to be in the next 1, 3 and 5 years. To do that, give your business a financial health checkup. When’s the last time you gave your business a financial checkup? 2 years ago? Never? An annual check up is a good rule of thumb. If you give your business a health checkup, you will want to see how things are going in these four areas:

  1. Profitability– Gross profit and net profit are two key measurements that indicate your overall health. Further, were you more profitable last year than the year before in dollars and percentage of sales? If you took a step back in either of these areas, it might take some further diagnosis to get to the root of the problem.

2. Asset Quality– The number of days sales you have in accounts receivable can determine the quality/collectability of your accounts receivable. Do any need to be written off? Do you have some clients that are chronic late payers? How about your inventory? Is it turning well or do you need to write some off that you’ve had on the shelf for a longer than normal time? If AR and inventory are turning at a healthy rate consistent with prior years, then great! However, if you had some changes, then you might want to see what they are and why.

3. Liquidity– Liquidity can mean a number of things, but most of my clients look hard at their cash balance to see if they have sufficient liquidity to handle payroll, purchases or other operating expenses as they come due. What did your cash balance do year over last year? Was it up or down and by how much? When companies are growing, cash tends to go down because growth requires cash. I don’t consider the availability on your line of credit as cash. I’m old fashioned, I look at the balance in the bank, but you may differ. Most businesses want to keep between 1 week and 4 weeks worth of sales in cash. If you are growing and don’t see that slowing down in the future, you may want to consider a line of credit of at least one month’s sales. Many business owners attempt to fund growth with internal cash and profits. However, it’s nice to have a safety if you need it.

4. Leverage– By definition, leverage is the use of borrowed money to increase sales and earnings.   While leverage may be beneficial in a boom period, when a recession comes and sales go down, there may not be enough cash to cover operating expenses and interest or principal payments. The amount of financial leverage can differ by industry, but most banks like to see a financial leverage ratio of no more than $3 of debt for every $1 of equity.

If you give your business a financial health checkup, you may see 1 or 2 of these areas you may want to work on to improve the overall health of your business. For more information on this topic or to speak about it with one of our consultants, please get in touch. Here’s to a healthy 2018!

 

Bill McDermott
bmcdermott@mcdfs.com
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