There's a certain aspect of running a small business that requires taking on the role of a company doctor. Small business financial health is a delicate system and one that needs to be constantly assessed. All small business owners hope that their business is financially healthy and profitable. However, unless you’re from an accounting background, it might not be immediately obvious what you need to look for when conducting a review of your finances and evaluating small business financial stability.
Dealing with numbers can seem scary for some and it can be difficult to know how to measure small business financial health and whether your business is, in fact, financially healthy. Incfile chatted with experts in budgeting and finance about signs of a healthy business and how to help decipher what kinds of things you should think about when it comes to analyzing financial health and profitability.
You Conduct a Basic Profit and Loss Analysis
A qualified financial analyst will be able to tell you if your business is financially healthy from a quick review of your records and financial statements. However, as a small business, you may prefer to be able to determine this for yourself without having to employ an expert.
Donna Tang, a budgeting and finance expert at CreditDonkey, says that the simplest indicator to look at is your profit and loss statement. “You can determine the profitability of your business by checking the net profit margin. Use a simple formula to calculate net profit: revenue – expenses = profit,” Tang explains. This gives you a general snapshot of how profitable your business is over a period of time.
If you want to delve a little deeper, Tang says that you can also look at whether your revenue is appreciating or depreciating over months. It can also be helpful to look at the number of sales earned through a specific period of time to try and analyze your customer acquisition and retention.
Financial Planning Has Been Important from the Beginning
If you can implement financial planning from the very beginning, your business is more likely to be financially healthy in the long term. Chelsea Cohen, co-founder of SoStocked, says that for small or young businesses, it’s important to plan and manage product stocks from the start. “You want to avoid financial stagnancy from both extremes — the first being under-ordering and missing valuable sales and the second from over-ordering with funds that could’ve boosted sales elsewhere,” Cohen says.
This all comes down to implementing good financial and business planning strategies from the start. Cohen explains that while success might fluctuate due to seasons or trends, planning can ultimately save you from financial loss, especially if you’ve taken the time to learn about your target audience and customers. Having a strong financial plan in place is a good start to being stable in the long term.
You Have Cash Reserves and Emergency Funds
One of the most important aspects of financial planning is setting aside an emergency fund or cash reserve, yet 32 percent of small businesses only have one month or less of cash reserves.
Ruth King, a successful entrepreneur known as "The Profitability Master," says that having a good cash reserve is one of the main ways to tell if a business is healthy. For a practical calculation, the minimum amount of cash should be “a company’s payroll in the busiest month of its year times three, plus the overhead in the busiest month of the year times six,” King says.
This should be considered a basic way of calculating a minimum cash reserve for healthy businesses. As the last few years have proven, the business world is as uncertain as ever and an emergency fund can help you stay afloat while you resurrect from any losses or change in trends.
You Invest in Growth with Available Resources
When analyzing your business’ financial health, you’re likely going to be drawn to the profitability and income statistics. However, having extra resources available may also mean that you have room for growth or scaling up.
Ryan Fyfe, COO of Workpuls, says that simply receiving more from customers than what needs to be paid out for in expenses means that you may have excess resources available. While this may be a good sign, it can also suggest an ability for scaling up or growing larger into new markets or new product lines.
"The more resources available within a company or organization the greater their ability becomes for scaling up — that is, growing larger into new territories or markets with similar products or product lines that result in increased sales volume that allows for hiring more staff, which then has an effect on earnings."
Fyfe continues, "Look at key financial ratios, such as debt/equity ratio, debt service coverage ratio, earnings before interest and taxes (EBIT), etc., which can give you a sense of the profitability of your operation."
Fyfe says that one of the most important measures to look for when it comes to financial health is return on assets, which is net income divided by total assets. This provides an overview of how efficient or profitable a business is relative to its assets or resources. However, if there is room to grow and expand, then it can be worth investing in such things like staff training or social media marketing, which will positively impact earnings and profitability in the long term.
Staying on top of your business's financial health will help you grow your business, make smarter business decisions and give you control over your future. A good place to start is by collaborating with a trusted accountant. Incfile's Accounting and Bookkeeping service will take care of everything for you and provide you with quarterly financial reports, so you always know where your business stands.
Jenna Scatena is a writer and content strategist with a love for stories that have never been told before. More than a decade of working with prominent magazines and brands informs her approach to impactful storytelling. Her stories have reached more than 30 million readers, won multiple awards and been anthologized in books. Jenna's work has appeared in Conde Nast Traveler, Vogue, Marie Claire, The San Francisco, BBC and The Atlantic. She's the founder of the editorial consultancy, Lede Studio.