Business owners are doing more regular financial health checks as they struggle with the cost of doing business, according to ScotPac’s recent SME Growth Index update.
The non-bank lender says these checks are becoming more entrenched as cashflow management and business planning tools in the wake of surging interest rates over the past 18 months. But why are they important? We’ll delve into the details.
Why you should conduct a financial health check
Firstly, financial health checks help you understand your business’s performance and potential for growth. They also alert you to potential dangers on the road ahead. Having the right information at the right time can help you make the right decisions.
A review usually involves scrutinising documents such as your balance sheet, income statement, cash flow statement and budget. You may also want to examine some common financial ratios related to your debt and equity.
What you need to look out for when conducting a health check
Red flags to look out for may include declining sales, falling profit margins, spending above your budget, rising debt, outstanding payments from customers and periods of high or low cash flow.
Profitability is one of the most important measures to examine. Basically, it is the difference between your revenue and the costs of doing business (or expenses). It reveals the overall success of a business.
Liquidity or your cash on hand is another crucial measure. It reveals your ability to cover your short-term financial obligations such as loans, wages, suppliers’ invoices, other bills and taxes.
Measuring your liquidity – for example, by using the current or quick ratios – can alert you as to whether you are about to face a cash flow crunch or perhaps, that you are sitting with too much cash which could be used on growing your business and other opportunities.
Cash flow highs and lows
Being aware that you are about to face a cash flow crunch enables you to take action, for example, by delaying some of your payments, negotiating new payment terms with your suppliers, putting a break on non-essential spending, boosting sales or tapping into outside finance.
Tips to help you assess your business’s finances
Research by Xero reveals that more than 90% of small businesses experience at least one month of negative cash flow each year and that the average small business cash flow is negative for 30% of the year. This equates to an average number of cash flow negative months of 4.2 in Australia.
Many free financial forecasting tools can be found online. Or you can do your own forecast by picking a period and listing all the income and outgoings expected over that period to assess whether your cash flow will be positive or negative over that period.
Other measures that could give you a good insight into your business include your gross and net profit margins and your coverage ratio (which examines whether your business can pay its debts).
Once you have looked at the various measures it may be useful to compare the performance of your business to others in the same industry. Here, the Australian Taxation Office’s small business benchmarks tool may be useful. If you have financial figures for at least three months, it will provide you with a report on the financial health of your business, including the main financial ratios and your business viability.
If your health check reveals that your business or expected cash flow isn’t in great shape, it might be a good idea to talk to your accountant or your broker. Recent research has found that SMEs are increasingly looking to brokers to help them ensure their lending arrangements are aligned with current and future financial goals and are enabling the best use of capital.
Contact us for tailored funding solutions to manage cash flow and ensure your business’s financial health.