I thought this would be a good follow-up to my last post “5 Things to Know Before You Borrow.”
Many of us get an annual physical, the doctor checks us out to see how things look like cholesterol, blood pressure, heart rate and respiration and compare them to last year. We want to manage our physical health to be the best version of ourselves we can be.
You may have just received your year-end financials and started making comparisons to last year, a financial physical. You want to get your financial house in order. So, here are 4 ways to tell if your financial house is in order by giving your company the financial physical I mention. Just remember the acronym, PALL.
Were you profitable last year? If so, did you make more or less profit this year compared to last year? How about gross and net margins? Are the margins up or down as a percentage of revenue? Asking the “what” questions is fine, but take an extra step and ask why? The possibilities include product mix if you sell multiple products, price increases, if you offered discounts or make some concessions. Other options could be your cost of materials or services are going up and you’re not passing those on to your clients.
How are you collecting your receivables or turning your inventory? Are your clients paying within terms or do you have some slow pay clients? If you have inventory, is there some slow moving or no moving inventory that is on your shelves? The more you have in receivables and inventory, the less you have in cash. Remember the saying, “cash is king.” You want to have good carrying levels of receivables and inventory, but keep excess to a minimum.
How much cash do you have on your balance sheet? Is cash up or down against last year and why? Growth always requires cash. So, cash is likely to go down if you’re growing and you’re financing your growth without a line of credit. A good rule of thumb is to have 15-30 days of sales in cash. Most business owners experience cash flow problems because they don’t keep enough cash in the bank. We’re going to talk about leverage in just a moment, but if you don’t have a line of credit and you have slow paying clients, cash could get tight.
How much debt do you have in your company compared to your net worth or shareholders equity. Leverage measures how much skin you have in the game, your net worth, vs how much your creditors have, your total liabilities. If you borrow every time you have cash flow issues, you could wind up with a lot of debt. Remember the 80-20 rule. Banks will start getting heartburn when more than 80% of your company is financed with debt and you only have net worth of 20%. Every company is different, but this a good rule of thumb.
With this information in hand, give your company a financial physical. Then decide what you might want to stop doing, what you might want to start doing and confirm what you want to keep doing. I hope 2016 is a great year of financial health for each of you.