When it comes to running a small business of your own, there are numerous things that you can find exciting. Entrepreneurs get to experience a lot of exciting roles such as handling marketing, recruiting staff, and working towards the implementation of your brainchild. While all of these roles have their charm, most entrepreneurs forget the importance of financial ratios and checking on the financial health of their business.
Managing the financial health of your business is not as exciting a role as others that an entrepreneur sees around them. Considering the boring technicalities of managing finance, entrepreneurs aren’t tempted towards overseeing finances or the financial well being of the business with the same interest.
We don’t believe all small business owners have an idea of what it takes to run the finances of your business correctly. However, you should keep a stringent check on the financial health of your business and make sure that all steps are taken for improvement.
Small business financial health is essential as the company happens to be fragile, and any neglect can impact your finances in the long run. The impact of poor financial management at the start of your business can be significant in the long-term.
Some of the reasons why you should look after your financial health with added attention at the start of the business are:
- Your startup is fragile right now, and any neglect or poor decision can end up impacting the success you make. If you want your business to succeed, you should make sure that the finances of your business are strategically managed and all due actions are taken for rectification.
- The plans and budgets you make after the start of your business matter a lot for success. You have limited starting capital to play with, which is why you should be frugal with your expenses. You should make sure that you don’t spend a lot on particular activities and remain economical with all of your costs. Any undue liability can jolt your financial statements and lead to multiple problems.
- The start of your new business is when you set all the benchmarks for the future to come. You should make sure that the parameters you set are followed by everyone and are implementable. You should keep a keen eye on financial ratios and should make sure that you keep calculating them to evaluate the financial health of your business.
The financial health of your small business is dependent on many factors, including the metrics you use for calculating different indicators.
To manage your finances in the best manner possible at the start of your business, you need to understand all of the essential metrics governing financial management inside a business. You can only succeed with your business plan if the business is financially healthy and can look after itself through the finances or revenue generated through operations.
You need to have an accountant or a trusted financial advisor by your side so that you know all of the different metrics that are at play here.
Go through these five metrics and understand their importance, because they play a strategic and vital role in defining the success of your small business in the long run.
Income is on top of the list for the metrics you should monitor, because of the importance that it holds. You need to realize that a stable income is the number one way to keep your financials steady in the long run. You should try to think of ways to secure selling opportunities and to increase your income for the better.
As a business owner, you would want as many income opportunities as possible. Income is perhaps the most critical metric in your business. The income you make isn’t just necessary for calculating current success, but it is also used to save for expenses that will come your way in the future. You need to understand different ways of increasing your income so that you can actualize the plans that you have for the future. The future of your business can be turned into success through the right strategies and planning. Business income should be on top of the list for you when you are planning things to have an eye on.
After the income of your business, your costs come across as the second most important financial metric of your business. Your business can only experience growth if you remain frugal with your expenses and try to limit it as much as you can.
Every business has its expenses. It is hard to run a business without costs, as you encounter expenses in one way or the other. Your costs also tend to have a direct impact on your profits, which is why they are the second most important metric in your business.
Your profits are generated by subtracting your expenses from the total for your income. The resulting figure would be known as your net profit. Thus, if you want to increase your earnings, you can do it by either increasing your income or reducing your expenses. Most entrepreneurs look to reduce the costs as much as they can because reducing expenses can directly increase the profits of your business.
Besides the cost of goods that you sell, you also need to consider the overhead expenses that come with running a business. These overhead expenses include the payment for the lease, utilities, paper towels in the bathroom, employee amenities, and rent payment. Have control over the amount you pay for overheads and direct expenses so that they don’t cut through the profits you make at the end of the day.
Cash is something that is just as important as your profits but is often neglected by entrepreneurs.
The cash you have in your business is a better way to check your buying power than the profits you make. Your income does tend to point towards good profitability, but unless and until these profits are fully realized, you cannot consider them ready.
The cash you have in your hands can be used for buying goods, making payments and doing anything else. Profits do tell a picture of your efficiency, but cannot be fully realized until they are earned.
Having studied the importance of cash, we now head to the importance of cash flow statement as a metric. Your cash flow statements indicate the flow of money inside and outside the business during a particular period. You need to make sure that all the flow of cash is documented, and that you don’t run out of money in a financial crunch.
You should always be on top of the money that you owe to your customers. Not only is this necessary for your credit profile, but it can also assist you with managing debt in a better manner.
If you do take a small business loan from a lender, make sure that you religiously follow the repayment plan that they give to you. Most private lenders happen to be relaxed when it comes to repayment, which is why you can get better deals than you would get from the bank.
Keeping a strict eye on your account payables and clearing their dues on time would paint a good picture on your credit profile. Lenders wouldn’t mind dealing with you, and you would get excellent business opportunities. Additionally, if you are getting goods supplied to credit, suppliers will offer you discounts on timely payments. Many suppliers offer discounts if their debts are handed over within ten days or a month. You can get these discounts through the proper management of your finances and the account payables you have for your business.
Other than your payables, you should also have a strict eye on your Accounts Receivables. You need to make sure that your receivables are reminded time and again about the money that they owe to you.
Your first aim should be to set payment terms with customers beforehand. Make sure that your customer knows when they should clear the dues without damaging their credit rating. If you feel that a customer is in no mood to clear their dues, then you should consider all legal formalities. Legal action can be taken against a customer that isn’t willing to make the dues on them.
If you let your Accounts Receivables stay for 70 days or more, then you will find an exponential increase in your ability to collect the loan back. Customers often try to extract the full benefit of the leniency that is shown towards them, by stretching the days forward.
Have a Separate Accountant
Having discussed all the key metrics of managing your financial health, we get to talk about the remedy that you should have in mind for maintaining the health of your small business.
The first thing you need to do to make sure that your small business finance is well taken care of is to hire an accountant for the job. When you start a new business, every penny counts for you, and you might consider hiring an accountant an additional process. But, let us warn you of the repercussions that come if you don’t hire a good accountant.
Keeping a check on all the expenses that you incur for your business will eventually get you the results that you are expecting from your company. Here we look at some of the benefits that you can get out of hiring a dedicated accountant for your business.
IT SAVES YOU TIME
It goes without proof that an accountant dedicated to looking after your small business finances would save you a lot of time. Regardless of the kind of operations you have, you will be pleased to know that your accounts are in safe hands and that you are saving time in the process as well.
Managing all the financial paperwork yourself, and keeping an eye on all the financial affairs in your organization can be a tough task, which is why you need to make sure that you keep a stringent check on issues within your organization.
An accountant who is au fait with all of the latest laws in the field of business accounting would make sure that you meet deadlines and can handle financial obligations without considering them to be a burden on your shoulders.
REDUCES TAX LIABILITY
A good accountant with the relevant experience in the field would know just how you can reduce your tax liability and the amount you incur towards the tax on a routine basis. Your tax liability involves the amount you pay to the government as tax for running your business and earning money.
Now, there are some fine statutes present within the law that can help you reduce your tax liability. Your accountant’s ability to identify these statutes and work on them will eventually help you out as you can save money on your tax payments.
Additionally, a good accountant will also implement knowledge from past experiences to know what is legal and what isn’t. They will make sure that you are on the right side of the law with all of your tax payments.
AVOIDS HEFTY PENALTIES
Carrying on from the point that we made above, you can get hefty penalties and fines if you aren’t complying with the tax guidelines and legal details mentioned by the governing authority in your state. Since you don’t have the relevant experience managing finance for an organization, you wouldn’t know about these private details.
Regardless of whether you intended to be non-compliant, or it happened because of general oversight, you will be charged for it and will be asked to settle the disputes through a fine or a penalty. The amount you incur here can be saved by getting the services of a full-time accountant.
HELPS YOU GROW YOUR BUSINESS
You can only experience true growth for your business if you keep your financial sector abreast with all the growth opportunities. Your inability to let your financial department grow alongside the business will come and haunt you in the long run.
If you have a dedicated accountant working for you in your new startup, you can rest assured knowing that your financial well being is taken care of. The financial health of your business is essential and dictates the growth of your business. You should discuss any growth opportunities with your accountant so that both of you are on the same page when it comes to financial and operational growth.
You should release a companywide memo alerting all of your staff about your growth plans, so that there are no silos, and that the organization is fully geared towards achieving growth. If a professional expert doesn’t manage your finance department, you will never be able to get over the worry of looking after it.
REMOVES TAX WORRIES
As we have discussed above as well, tax is perhaps one of the most critical factors that you should manage while running your business. Considering the importance it has, tax is also one of the most troublesome aspects to control.
You should make sure that tax is taken care of, and that there are no irregularities whatsoever in your tax payments. If you miss any of the dates for your tax payments, you can be heavily fined. Your dedicated resident accountant can save you from this hassle and can make sure that your payments are made at the right time.
HELPS YOU SELECT THE RIGHT FINANCING OPTION
If you’re experiencing growth, there is a good enough change that you will also require financing from elsewhere. You need to make sure that you have the funds available for growth at all times. If you lack such funds, then you have to consider external sources of finance for the move.
If you’re looking for a small business loan from an external lender, then you need to make sure that you choose the best option possible. A dedicated accountant would not only help you shortlist the best private lender available but will also help make sure that the lender approves your loan proposal.
Your loan proposal can be revoked because of multiple reasons, including weak profits, poor credit history, and insufficient operations. However, if your accountant can reach out for the best small business finance option, then they surely will secure the proposal for you. Thus, having a dedicated accountant for your business is nothing less than a blessing for you.
Ways to Assess Your Business Through Ratios
Once your business has been around for more than two quarters or half a year, you need to take into perspective the importance of assessing your business. You should know that business assessments are an essential part of running a small business, as you should make sure that all the heads are being managed with the precision and efficacy you require.
As we have already discussed, the financial health of your business is vital for multiple reasons. And, the best way to check or assess the financial health of your business is through the use of financial ratios.
These financial ratios act as a litmus test for your organization and give you an indication of what is required for you in the long run:
Liquidity ratios measure the amount of cash and other convertible assets that you have for covering the debt of your business. Liquidity ratios give you an idea of how your business stands as far as your ability to pay a debt is concerned.
The liquidity ratios consist of two formulas known as the quick test ratio and the current ratio. The quick ratio is also referred to as the acid test ratio. While the current ratio considers all current assets as easily cashable assets, the acid test ratio does not view your inventory at hand as a liquid ratio.
Efficiency ratios are usually measured when you are into business for quite some time now and have reliable figures required for measuring inventor turnover and other metrics. The inventory turnover is the most basic efficiency ratio around, as it gives you a good indication of how long it takes you to buy and sell inventory. You should check the industry standards around you to identify whether the answer you get is in line with the industry standards that are being followed around us.
The inventory turnover ratio can point towards flaws in the selling and inventory stacking procedures, which is why you must keep monitoring it.
Profitability ratios are essential for computing the profit generation ability of your business. The markup and the margin happen to be the two most basic methods of assessment here. The margin is used for calculating the percentage of profit in comparison to the sales made. The financial markup is the percentage of net profit in comparison to the cost of goods that you have sold during this period.
Additionally, you have the Return on Equity and Return on Assets ratios here, which give you an idea of how profitable your business is in comparison with the equity you have and the assets you own.
These ratios are used for defining your dependence on long-term liabilities in your business. The debt to equity and the debt to asset ratios are used here to find out how much of your business is relying on your long-term debt.
The answers to all of these ratios will give you an indication of your business’s financial health, and what you need to do to improve the finances.
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