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You don’t have a business without sales. But to have a truly sustainable business, you need more than just enough money in the bank to pay the bills. Good financial health allows your business to thrive and continue to grow if you choose.
Here’s how to understand and improve the financial health of your business.
Why Small Business Financial Health Matters.
When you feel healthy, everything is easier when you are not. The same is true when your business is healthy; You will be better able to deal with the challenges that arise.
When you have a financially sound business, it is easier to get financing or attract investors. If you decide to sell, it will be easier for you to find a buyer.
Here’s how you can make financial health part of your business strategy.
What determines the overall financial health of a business?
You don’t have to rely on gut feeling to determine if your business is healthy. There are common business metrics and financial ratios used to understand the health and viability of a small business.
Here are several ways small business owners can use financial information to gain a better understanding of their companies’ financial health.
If the following information makes you feel overwhelmed, don’t worry. In a moment, we’ll provide tools and strategies to make it easier.
Profitability
As a business owner, the first thing you want to do is create a profitable business. At its simplest, it means you’re making money. However, there are several profitability ratios used to analyze business profitability: gross profit margin, operating profit margin, and net profit margin. Each contributes unique insights into the health of your business.
Analyze the balance sheet
The balance sheet shows the value of a business at a particular point in time. It reports the company’s assets, liabilities, and owner’s equity. The basic formula is typically Assets = Liabilities + Owner’s Equity.
Liabilities include those owed by the business, such as loans and leases, but also include current liabilities such as rent, tax liabilities, and payroll expenses.
Assets include things of value owned by the business. It can include not only cash in the bank, but also accounts, inventory and real estate. Intellectual property can also be an asset.
Owner’s equity is anything left over after liabilities are taken care of.
Income statement
An income statement (also called a “profit and loss statement”) provides insights into a business’s income and expenses over a period of time. It helps you understand if your business is making (or losing) money.
You can draw up your own income statement or generate one from accounting software. Either way, your overall goal is to compare income and expenses. In the revenue category, you can have gross profit (revenue minus cost of goods sold), operating income (gross profit minus operating expenses), and net income (income before taxes).
Analyzing your income statement gives you an opportunity to assess whether increasing revenues or reducing expenses will help improve the financial health of your business. It can also alert you to situations where your business seems to be making a lot of money but is becoming less profitable. And it helps you track your business’s financial performance over time.
The importance of cash flow management
How you handle cash flow will be key to how healthy your business is. A business that makes a lot of sales but struggles to collect payments and therefore consistently pays its bills may not be profitable in the long run.
A healthy cash flow means that your business is bringing in enough income over time to pay employees, suppliers, taxes and other obligations on time.
Unfortunately, slow cash flow is a recurring problem for small businesses. There are many ways to measure cash flow. Among them, free cash flow is widely used to determine the cash flow available to pay debts as well as pay interest or dividends to investors.
After increasing profitability, improving cash flow can be one of the most important ways to impact your business.
Fluid: What is it and how is it important?
Business liquidity refers to how easily assets can be turned into cash to meet short-term financial obligations, meaning those that are due within a year or less. With insolvency, a business may find itself unable to pay those bills and may be forced to borrow or borrow.
Small businesses can maintain financial health when they incorporate systems.
Most business owners don’t start a business because they want to pour financial statements—unless they start an accounting business! You want to use systems and tools that make it easy to manage and improve the security of your business.
Choose and stay with a financial management system
You need to choose a financial management system that works for your business. You need at least three components:
- Commercial bank account
- Business credit and/or debit card
- Accounting software
A business bank account should be the central hub for all financial activities of your business. Business income is deposited there and business expenses are paid from it.
Even if you use payment platforms like Paypal or Venmo, it’s wise to have funds from those accounts deposited into your commercial bank account so you can have a centralized view of your business finances. This can also help when it comes to getting approved for financing, as many lenders want to review commercial bank statements.
Don’t mix your business and personal finances. If you need money from your business for personal expenses, pay yourself (like a salary or an owner drawing) and then pay your personal expenses from your personal account.
A business bank account that provides insight into your business finances helps you identify trends and stay on top of your business’s health.
You also need a math program. Even if you hire an accountant, it’s a good idea to keep your own access so you can check in regularly. If you need to outsource your accounting, you can change access without missing a beat.
Plan for the unexpected
Just as an illness or accident can put a damper on your personal health, your business may experience unexpected financial problems from time to time. Paying late (or never paying), inflation (!), a new competitor, a supplier going out of business, a lawsuit from a disgruntled customer, equipment that needs to be replaced or purchased are just a few examples. From the types of emergencies that can arise.
To play for the unexpected, you need to prepare in three ways:
- Keep cash reserves for emergencies.
- Line up access to capital before you need it.
- Have adequate business insurance.
You cannot avoid or plan for all potential problems. But they create a safety net that makes it easier to respond when things go wrong.
Access to capital
Almost all businesses need access to a line of credit. With lines of credit, you can borrow what you need (up to your credit limit) when you need it. Suitable for short term financial needs.
Additionally, a business credit card can give you access to a line of credit.
In addition, you may need a small business loan. For example, you may need a term loan for specific projects, commercial real estate loans, or special financing such as receivables financing to extend funds from cash-strapped customers.
How to prioritize the financial health of your small business
Building a financially sound business is a commitment. It makes it easier to create routines and use available resources, just as we get in physical form.
Don’t be afraid to get help. Your accountant, or a free business consultant from SCORE or your Small Business Development Center can be invaluable as you work to prioritize. Investing in the financial health of your business can pay off in a business that will financially support you and your family in the long run.
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