For every business, being constantly aware of the financial position is integral for a number of reasons. Knowledge about how the enterprise is faring financially results in improving operational efficiency, educated decision-making, strategic forecasting and management of resources, including talent. Reasonable knowledge of a few key indicators and some simple ratios can reveal plenty.
Ways to Determine the Financial Position of Your Business
1. Analyze Financial Statements and Ratios:
It is important to create accurate financial statements such as balance sheet and the income and expenditure statement, and calculate related ratios like gross profit, net profit, earnings before interest, taxes, depreciation and amortization (EBITDA) etc. This will tell you if your business is making a profit or a loss.
Even if the enterprise is making a profit, whether it is still in the black after paying off its interest and tax obligations, calculating depreciation and meeting other overhead expenses must be assessed. There are companies who have a gross profit but a net loss on their financial statements. Some companies might even show earnings before their final tax payments and interest obligations have been calculated. But once the EBITDA numbers come in, the figures do not look so impressive. These are all numbers that the business needs to be aware of.
2. Analyze Revenue and Accounts Receivable Cycle:
A business needs liquid cash at all times or at least assets that can be converted to cash within a short notice. Are your debtors paying you back on time? Is your working capital situation stable? Are your revenues constantly more than your expenses? These are all critical questions to be answered. Revenues must be generated from core operations; a rare case where you monetized some fixed assets cannot be considered a viable revenue stream.
3. Analyze Inventory and Investment:
Wastage of resources must be checked at all times. Investment in the business in terms of capital and raw materials and inventory and the output generated, as a result must be validated against each other. The proportion of wastage, quantity of finished goods, and the products that are eventually sold in the market are all key indicators of business operations. The company needs to be careful if the numbers show large disparities among them.
4. Check Expenses:
Always keep an eye on business expenses. If they are rising all the time, ask the operational heads why that is so and how they can be curbed. Dig deeper into these numbers to find out if they are one-time expenses or an irreversible trend.
5. Analyze Liabilities and Capital:
Examine the borrowings of the company, the proportion of shareholder’s equity and owner’s capital. The more you borrow, the more interest you will have to pay. The greater the shareholder’s equity, the higher the possibility that you might not have enough control over the company and the likelihood that you will have to pay dividend from time to time. Ownership numbers are of vital importance to the promoters of the company. Any change in these numbers should only be done with careful consultation and great foresight.
While the micro aspects of finance and accounting can be left to the accountants of the business, it is important for management to be able to analyze key numbers on a periodic basis, and reach logical conclusions regarding the economic health of the business. They should understand how finances work, which items are important and which ones are not. They should be able to make smart inquiries about crucial aspects so that they know if the business is in good shape or not. If it is not, then the management should be able to take action quickly.
Credit: Senthil Kumaran, Operations Manager – Finance and Accounting, Invensis Technologies