Is Your Business Healthy? How to check the Pulse…
We are approaching mid-year; the economy is definitely opening back up. Segments that were that were not impacted by this past year seem to be busier than ever. Companies that were impacted, especially in the service sectors are welcoming the increased demand. Many of the businesses impacted are now finding the biggest challenge is finding employees to fill open positions. On the surface this is all good, right? But what about the pulse of the business? How do you check it? How do you monitor it?
When business is good, we tend to have very short-term memories about slower economic periods; even reviewing the uncertainty of where many companies were at just 12 months ago is already beginning to fade. The here and now is where many businesses tend to focus a large percentage of their energy, but often it is more of a triage approach verses checking the pulse regularly to monitor and manage the health.
Without monitoring the pulse, businesses tend to operate in more of a reactionary mode. The simplest example right now is the rising cost of labor and materials. Input costs for just about every business are increasing at an accelerated rate. If your company isn’t proactively keeping a pulse on these your profit margins could be running in the red and you would not even know it, especially in low margin industries.
Checking Your Business Pulse…4 places to monitor
- Labor Efficiency: With labor costs rising, efficiency of your labor is more critical than ever. Filling jobs with warm bodies is tempting, but if they are not able to contribute it may be hurting your business more than helping. It is part of the process, but adding unskilled labor increases the man-hours of labor required to complete a project. Before you add more people, discern where there are opportunities to be more efficient with the team you already have in place. Are the metrics you’re measuring meaningful in the 2021 work environments that are often remote or hybrid? Remember, even small increases can have a significant impact.
- Overhead & Inventory: A broad spectrum of items fit in this bucket. When business is picking up, it’s easy to get caught up in the activity and not the margins. If your business has inventory, and inventory is tight, it’s easy to justify increasing orders. 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%? Is your compensation tied to profitable sales or gross sales?
- Accounts Receivable & Accounts Payable: It’s a fact, when business is growing, so is AR and AP, they almost always go hand in hand. The challenge with this is businesses tend to be more lenient with terms (AR) until they feel a pinch for cash (AP) or access to it. 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? What about your payables…are there better terms available?
- Financial Ratios: There are dozens of ratios a business can monitor. Unfortunately, these are often viewed as bean counter metrics and the valuable information they can provide is never revealed. Monitoring a few key ratios in your business is a great way to insulate your business from a change in the business climate. The foundational ratios every business should monitor are…
- Working Capital Ratio
- This is your Current Assets-to-Current Liabilities ratio. If less than 1 it means you can’t satisfy short-term expenses. That is not good. (IE: money to turn on the lights) How much cash (or cash equivalent) can you get your hands on quickly?
- Debt-to-Equity Ratio
- If your company has a lot of assets like inventory, vehicles, buildings, real estate, this ratio is important. The lower the D/E ratio, the longer the company can survive, especially if there is a downturn, because they have less debt to service. Your accountant or a trusted advisor may be a good source in helping calculate and determine a healthy D/E ratio for your industry.
- Profits-to-Total Revenue Ratio
- The actual net profit margin when each transaction is completed. Would you rather have a business with $5 million in revenue and 10% net profit or $50 million in revenue with 1% net profit? They both produce $500,000 of net profit. If these two examples were in the same industry, which would you want to own?
- For Startup companies, this ratio is often a negative profitability ratio. In this case, the focus is monitoring the direction the ratio is trending.
What about you? How is your business doing as the economy is opening back up? Are any of these blind spots you’re missing? Do you feel like you know the pulse of your business? It is healthy? Do you have a favorite ratio you track… why? How good do you feel about the overall health of your business?
As always, we value your feedback in the space below. Chris Steinlage, Kansas City Business Coach