Knowing how to determine the financial health of your small business is a vital skill.
By Manali Shah
Small businesses contribute immensely to the economy and are a critical source of income for millions of individuals and families. Strong financial health allows small businesses to continue to operate even when a critical piece of equipment breaks down or allows them to set up shop at a new location successfully. To thrive and grow, proprietors need to be able to check and measure the business health of their companies. Here are a few tips to do so.
1) Analyze the balance sheet
A balance sheet serves as a snapshot of a business’s assets, liabilities, and owners’ equity. The assets should always be equal to the sum of liabilities and owners’ equity. The balance sheet should help you analyze how much debt the company has, relative to equity. It will also show you how liquid the business is in the short term (less than a year), the percentage of tangible assets and the percentage that comes from financial transactions, the duration it takes you to receive outstanding payments from customers and to repay suppliers, and how long it takes to sell inventory the company keeps on hand.
2) Analyze the Income Statement
The income statement reflects an organization’s financial position and performance by considering revenue, expenses and profits earned. It helps you analyze how much revenue is growing over certain accounting periods, the gross profit margin for goods and services sold and the percentage of revenue that results in net profit after all expenses. Further, an income statement will help you understand if the business can cover its interest repayments on debt, and how much the business repays to shareholders versus how much it reinvests.
3) Analyze the Cash Flow Statement
A cash flow statement gives a business owner key insights into how his/her company used its cash during a particular accounting period. It shows the sources of cash flow and the various areas the cash was spent (categorized into operations, investing and financing activities). It helps you analyze the liquidity of your company, the free cash flow a company generates to further invest in assets/operations, and gauge whether overall cash has increased or decreased.
4. Financial Ratio Analysis
Financial ratios are powerful tools that help you make sense of the data presented in a company’s financial statements. They help you understand past performance and how your business fares compared to its competitors. Financial ratios like gross profit margin and net profit margin are commonly looked at, but here are a few more important ratios: coverage ratio (indicates the ability to meet a company’s financial obligations and cover its debt), debt-to-equity ratio (the percentage of debt versus equity that the company uses to finance itself), return on equity (the ability to use equity investments to earn profit) and return on assets (the ability to manage and use a company’s assets to earn profit).
Checking the health of your business should lead to actionable insights that help your organization scale and become more profitable. The Wadhwani Advantage program empowers businesses with capabilities to maximize their growth potential. The program also provides businesses with access to dedicated advisors who are uniquely positioned to understand the business challenges and, therefore, are a powerful check on the business health.
Take advantage and apply to be a part of the ‘no fees, no equity’ program today:
(Businesses with INR 25 Cr+ revenue and employee strength ≥ 100, intent to grow 10x and a commitment to learn can apply)