Knowing if your company is doing well is somewhat simple. You’ll be able to make payroll, pay your monthly bills and expenses, and have money to spare.
Here are a few ways to distinguish that your company is in good financial health:
You should see a steady increase in your revenue month-to-month and year-to-year when viewing your income statements. These increases don’t necessarily have to be large. Even an increase of a few percentage points shows improvement in your business’ financial standing.
While your revenue increases, your expenses should remain flat. If your business grows significantly, your short-term expenses may rise; however, this increase should correspond with your revenue increase. For example, if your revenue increases by 1.5% year-to-year, your expenses should not increase more than 1.5% during the same time.
If you’re taking your revenue and solely investing it back into your business, you’ll be asset-rich but cash-poor. A low cash balance shows that your business is unstable and not sustainable. Keeping a healthy amount of cash saved in the bank provides you with the security of knowing that if any unforeseen circumstances arise, you have the resources necessary to deal with them. That security also means you won’t need to incur more debt to cover an unexpected cost.
As a business owner, you should pay close attention to your debt-to-asset ratio as well as your debt-to-equity ratio, also known as solvency ratios. These ratios measure how much your business owes weighed against how much your business is worth. The lower the number, the better. Specifically for your debt-to-asset ratio, you should look to maintain a 2:1 ratio.
Measuring your profitability ratios gives you a good idea of the status of your profit margin. Take your annual net profits and divide it by your annual sales. Your profit margin may still be low, depending on a variety of factors. Your profitability ratio is “healthy” when it’s high.
Activity ratios measure how your business manages its assets. Three of the most common activity ratios are:
Asset Turnover: This formula takes your sales and divides it by your assets. A high turnover ratio translates to more efficient asset management.
Inventory Turnover: This formula is your cost of sales divided by your average inventory. A high inventory turnover ratio means you’re effectively managing your inventory.
Operating Expense Ratio: Divide your operating expenses by total revenue. This measures how much you spend in order to generate revenue. A low ratio demonstrates efficiency.
Acquiring new clients generates a higher cost than working with the same customer. Consistently working with new clients as well as repeat customers creates multiple revenue-generating options for your company.
Haven’t started your business yet? Check out our guide!