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Is your small business financially sound?find out

A business cannot exist without sales. But running a truly sustainable business requires more than enough cash to pay the bills. Good financial health allows your business to thrive and continue to grow as needed.

Here’s how to understand and improve the financial health of your business.

Why small business financial health matters

Everything is easier when you are feeling well than when you are not feeling well. The same is true if your business is healthy. You can better handle the challenges that arise.

Having a financially sound business makes it easier to raise capital and attract investors. If you decide to sell, it will be easier for you to find a buyer.

Here’s how to make financial health part of your business strategy.

What determines the overall financial health of a business?

You don’t have to rely on intuition to determine if your business is healthy. There are common business metrics and financial ratios used to understand the health and viability of small businesses.

Here are some ways small business owners can use financial data to better understand the financial health of their business.

If the information below overwhelms you, don’t worry. Soon we will 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 the simplest level, it means you are making money. Gross Margin, Operating Margin, and Net Margin. Each contributes a unique insight into the health of your business.

Analyze the balance sheet

A balance sheet represents the value of a company at a particular point in time. Report the company’s assets, liabilities and owner’s equity. The basic formula is usually Assets = Liabilities + Owner’s Equity.

Liabilities include things your business owes, such as loans and leases, but also current liabilities, such as rent, tax liabilities, and labor costs.

Assets include anything of value that a business owns. It includes not only bank cash, but also accounts receivable, inventory, real estate, etc. Intellectual property can also be an asset.

An owner’s equity is what remains after the liability is recorded.

Profit and loss statement

An income statement (also called an “income statement”) provides insight into a company’s income and expenses over a specific period of time. It helps you understand if your business is making a profit (or losing money).

You can create your own income statement or from your bookkeeping software. In any case, the overall goal is to compare income and expenses. Revenue categories can include gross profit (sales less cost of goods sold), operating profit (gross profit less operating expenses), and net profit (profit before tax).

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 appears to be making more money but is becoming less profitable. It also helps you monitor the financial performance of your business over time.

Importance of cash flow management

How you handle cash flow is key to the health of your business. A business that makes a lot of sales but struggles to collect payments and as a result is constantly late paying its own bills may not be successful in the long run.

Healthy cash flow means that a business delivers revenue in sufficient time to pay its employees, suppliers, taxes, and other obligations on time.

Unfortunately, slow cash flow is a common problem for small businesses. There are several ways to measure cash flow. Among them, free cash flow is often used to determine the cash inflow available to pay debt, as well as interest and dividend payments to investors.

After increasing profitability, improving cash flow is one of the most important ways to influence your business.

Liquidity: what is it and how important is it?

Liquidity in a business often refers to how easily assets can be converted into cash to meet short-term financial obligations, i.e. obligations payable within one year. Without liquidity, a business cannot pay those bills and may be forced to borrow or default.

Small businesses can stay financially healthy when systems are built in

Most business owners don’t start a business because they want to pour into their financial statements, unless they start accounting. You’ll want to take advantage of systems and tools that make it easy to monitor and improve the health of your business.

Choose and stick with your financial management system

You should choose the financial management system that is right for your business. At least three elements are required:

  • business bank account
  • Corporate credit and/or debit card
  • Accounting software

A business bank account should be the central hub for all the financial activities of your business. Business income is deposited there and business expenses are paid out of it.

Even if you use a payment platform such as Paypal or Venmo, we recommend that you deposit funds from those accounts into your business’s bank account so that you have a centralized view of your business’ finances. This is also helpful when getting loan approvals, as many lenders want to see their business bank statements.

Don’t confuse business with personal finances. If you need money from the business to pay your personal expenses, pay for it yourself (either as a salary or an owner’s lottery) and then pay your personal expenses from your personal account.

A business bank account that provides financial insight into your business can help you identify trends and understand the health of your business.

You also need an accounting program. Even if you hire a bookkeeper, we recommend that you maintain your own access so that you can check in regularly. If you need to hire someone to do your bookkeeping, you can change access right away.

prepare for the unexpected

Just as sickness and accidents can damage an individual’s health, businesses can sometimes face unexpected financial hardships. Clients late on payments (or not paying at all), inflation (!), new competitors, out-of-business suppliers, lawsuits from disgruntled customers, equipment that must be replaced or purchased are just a few examples. The type of emergency that may occur.

To prepare for the unexpected, you should prepare in three ways:

  • Set aside a cash reserve for emergencies.
  • Prepare access to capital before you need it.
  • Maintain proper business insurance.

You can’t avoid or plan for every potential problem. But it creates a safety net that makes it easier to react when things go wrong.

Access to the capital

Virtually all businesses should have access to credit lines. A line of credit allows you to borrow what you need (up to your credit limit) when you need it. Perfect for short-term funding needs.

In addition, a business credit card gives you access to credit lines.

Additionally, you may need a small business loan. For example, you may need specialized financing such as a term loan to finance a particular project, a commercial real estate loan, or invoice factoring to advance funds from a debtor.

How to make financial health a priority for small businesses

Building a financially sound business is a commitment. Just like getting fit, creating a routine and using available resources makes it easier.

Don’t be afraid to ask for help. An accounting professional or a free business mentor from SCORE or the Center for Small Business Development can prove invaluable when working on your priorities. The return on investing in the financial health of your business can be a business that financially supports you and your family in the long run.

This article was originally written on July 29, 2022.

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