Business Management Articles
Keep Your Business Financially Fit
Business Times
October 2007
By Mark Smith, Partner
Many of us have the best intentions: eat right, exercise, get plenty of rest. Despite these good intentions, sometimes the scale continues to rise and our clothes begin to squeeze. That’s the signal -- time to hit the gym.
Just as we have to maintain our own physical health, business owners need to stay on top of the financial health of their companies. It’s easy to get caught up in the busyness of operating a company, only to look up one day and notice that the organization is no longer financially fit, but has become “financially flabby.”
Just like our bodies, flabbiness can lead to health risks for a company: critically short cash flow or a loan that’s called in. To avoid unexpected crises like these, here’s a regimen that can help you monitor the financial health of your company.
- Prepare and review financial projections every quarter:
- Profit and loss forecasts to identify anticipated sales and expenses;
- Projected balance sheets to determine the company’s anticipated financial position; and
- Cash flow forecasts to estimate the amounts and timing of cash expected to flow into and out of the business in the coming year.
These projections can help you to anticipate slow cash periods, budget for the organization’s cash needs, plan for capital improvements, estimate future financing requirements, and plan the appropriate strategies. Projections also help to point out what areas of the business may need strengthening.
- Carefully review financial statements every month:
- Cash flow statement to track the daily inflow and outflow of cash and to identify periods of slow revenue and high expenses;
- Income (profit and loss) statement to see an overview of sales, gross profits, expenses and net profit/losses; and
- Balance sheet to assess assets, liabilities and net worth.
Compare these statements with projections and with month-to-month and year-to-year statements to determine whether you are achieving your goals, to identify trends and to establish profitability benchmarks.
- Review the following financial ratios every month to measure profitability, liquidity and efficiency. And, if you have a banking agreement that requires you to maintain additional financial ratios, track those ratios as well.
- Gross margin (sales – cost of goods sold / total sales)
- Net profitability (net income/net sales)
- Average number of days for payables
- Average number of days of receivables
- Debt-to-equity (total debt / net worth)
- Current ratio (current assets / current liabilities)
- Inventory turnover
Track and compare these ratios for your own business and with those of others in your industry sector in order to monitor your performance against industry standards.
- Regularly monitor cash flow: know your cash balance at all times, monitor sales and reconcile them to bank deposits every week, reconcile the cash flow statement with the bank statement every month, and review accounts payable and receivable and cost of sales to ensure ordering and pricing are in sync.
- Review expenses every quarter and eliminate those that don’t demonstrate a measurable return. As well, prior to purchasing big-ticket items like equipment and leasehold improvements, be sure that they will make a direct contribution to the business.
- Build a cash reserve. If you experience a business downturn or customers are unable to pay, this capital could save your operation. Create a reserve by negotiating an overdraft option with your financial institution or depositing funds every month into an interest-bearing account or a low-risk investment vehicle.
- Secure backup financing. Review the terms and conditions of loans, leases and mortgages and ensure they allow a buffer that can assist the business in the event of a temporary period of difficulty.
If possible, meet with your current lenders to determine whether longer-term agreements may be appropriate or whether you may be able to reduce interest rates and payments by refinancing. It’s also important to stay in touch with lenders; you don’t want them to forget who you are when you most need assistance.
- Expand your financing options. Investigate other lenders who may offer additional sources of financing, including commercial finance companies and institutional lenders. Some suppliers or customers might also be sources of working capital.
- Secure commitments in writing and stay in touch with backup lenders so you can access these sources quickly if necessary.
Keeping your company in peak financial shape is a matter of discipline. By adopting a regimen such as this, you can monitor the health of your company – and do away with harmful financial flabbiness.
Mark Smith is a partner of BDO Dunwoody LLP (www.bdo.ca). One of Canada’s leading accounting firms, BDO helps entrepreneurs and family businesses succeed. You can reach Mark in the Mississauga office at (905) 270-7700 or marksmith@bdo.ca.
