Are You Keeping Your Business Financially Healthy?
It’s the middle of the year and overall most businesses are continuing to ride the current economic growth cycle we’re on. Weekly, we have clients talk about the challenges of finding employees to fill positions. Amazon may be taking over the world but all-in-all there are still a lot of small businesses experiencing growth and prosperity in our ever-changing economy.
When times are good in business, we tend to have very short-term memories about tougher financial periods, even if we survived a past downturn in the economy. Plus, several companies that have become household names today weren’t even around in 2008 (the last big downturn) so their business trajectory has been nothing but sunshine and blue skies. It’s hard to imagine stormy weather if you have never experienced it!
It’s times like these that have the potential of setting businesses up for hard falls if they aren’t monitoring the pulse of their business. It isn’t just about being healthy in good times but being able to withstand a downturn in the business cycle too.
Keeping your business financially healthy…4 places to monitor
- Labor Efficiency: When businesses get busy, the gut reaction is to hire. When qualified labor for specific jobs are in short supply it is common to lower standards just to fill the job. Adding unskilled labor typically only increases the man-hours of labor required to complete a project. Before you hire more people, see if there are opportunities to be more efficient with the team you already have in place. We work with several clients who measure efficiencies and you might be surprised at what a difference it makes. Even small increases can have a significant impact on the bottom line.
- Overhead & Inventory: This covers a lot of territory (including indirect labor). But when money is flowing in it is easy to get very loose with the checkbook and start spending. If your business has inventory, it’s easy to justify stocking up (more is better…). But what happens if demand slows? What if an item in demand today is replaced by a better widget tomorrow? If you need more space, will your business be able to survive the additional annual expenses should revenues decrease by 25% – 30%? Likewise, a risk in service related companies is not keeping compensation tied to profitable sales. A profit sharing plan (one-time bonus) is great, but if the model is simply increasing salaries and benefits you’re increasing the cost to open the door each morning, regardless of sales.
- Accounts Receivable: When business is growing, so is A/R, they usually go hand in hand. The challenge with this is businesses tend to be more lenient with terms when they aren’t feeling a pinch for cash. If you’re in growth mode you probably don’t have a lot of excess cash anyway. Every business should have credit policies with their customers & credit limits should be reviewed regularly (at least 1X/yr). What is your average age of receivables? Is it trending up or down?
- Financial Ratios: There are dozens of ratios a business can monitor. Unfortunately, many business owners blow these off and view these as bean counter metrics and miss out on the valuable information they can discern in a few simple calculations. Monitoring a few key ratios in your business is a great way to insulate your business from a change in the business climate. Three ratios every business should monitor are…
Working Capital Ratio
- This is your Current Assets-to-Current Liabilities ratio. Anything less than 1 means you can’t satisfy short term expenses (IE: money to turn on the lights) with cash on hand or things you can easily convert to cash. How much cash can you get your hands on quickly?
- This is a big one for companies with a lot of “stuff” like inventory, vehicles, buildings, real estate. The lower the D/E ratio, the longer the company can survive in a downturn because they have less debt to service. Your accountant or a trusted advisor may be a good source in helping you determine your current D/E ratio and what is considered healthy for your industry.
Profits-to-Total Revenue Ratio
- This is the actual net profit margin when all the dust settles. Would you rather have $1M revenue with 20% net profit or $20M revenue with 1% net profit? They both produce $200,000. If these two examples were in the same industry, which would you want to own? There is a healthy range for profitability – it varies by industry, location, maturity, but higher profits are always better. Startup companies often operate with a negative profitability ratio; the financial health, in this case, is determined by monitoring the direction the ratio is trending.
What about you? What do you monitor to gauge how healthy your business is? Has the current economic cycle been good to you? Do you have a favorite ratio you monitor? How confident do you feel about the financial health of your company? How do you feel about the overall health of your business?
As always, we value any feedback in the space below.
Chris Steinlage, Kansas City Business Coach