A lack of understanding about the financial side of business is one of the biggest reasons small businesses fail.
How do you monitor the health of your business? Are you like most small business owners, only taking a quick peek at your bank balance like the brush of a hand on a feverish child's forehand? Or do you dig deeper, making sure you get an accurate diagnosis? Let's examine how checking Overall Value and Profitability on a regular basis can help you accurately monitor the health of your business.
Overall Value
AREAS EXAMINED
Assets - everything you own or is owed to you
Liabilities - anything you owe to others
Equity - value of the owner or shareholder interests in the company
DIAGNOSTIC TESTING
Equity = Assets - Liabilities
This equation is called the Balance Sheet equation and is used to create the Balance Sheet. Examining the value of everything you own against the total of everything you owe gives you your interest in the company and is an indicator of the overall value and health of your business.
Debt-to-Equity Ratio = Total Liabilities / Total Equity
A high debt-to-equity ratio indicates your business operations are being financed instead of supported by incoming revenues. Your business will not survive under these circumstances.
Profitability
AREAS EXAMINED
Sales - positive cash flows from sales or services provided
Cost of Sales - costs directly related to sales
Expenses - costs not directly related to sales but necessary to operate your business
DIAGNOSTIC TESTING
No matter what type of business you own, profitability is essential for monitoring the health of your business. If you are not making money, your business will not survive. Both Gross Profit and Net Profit need to be determined.
Gross Profit = Sales - Cost of Sales
It is important to capture all the costs directly involved in acquiring products for sale or providing a service to determine if you are pricing the sale of those products or services appropriately. If you are experiencing a low Gross Profit or, even worse, a loss then your pricing model needs some serious reconsideration or your business will not survive.
Gross Profit Margin = Gross Profit(Loss) / Sales
Tracking your Gross Profit Margin percentage over time allows you to monitor your pricing structure to determine if you are adjusting your selling prices to appropriately reflect changes in the costs. This promotes healthy growth.
Net Profit = Sales - Cost of Sales - Expenses
Net Profit can help you understand the true cost of running your business and is an indicator of health. Good net profit is crucial if you are seeking financing or investments in your business.
Profit Margin = Net Profit / Sales
A high profit margin indicates a very health company. A low profit margin could indicate bad money management which is very unhealthy.
Now that you've learned how to examine Overall Value and Profitability, you are better equipped to accurately monitor of the health of your business. Sometimes, though, you find that you need the help of a professional for a more thorough examination and diagnosis. If you find that is the case with you, do not hesitate to reach to me. I am always happy to help!
Wendy