Working The Numbers

Continuing my series on cashflow and effective business financial management (you can read my previous posts here, here, and here), this post proposes some things you can do to ensure the financial health of your business.

Managing your finances successfully will ensure you never run out of cash and will help you take advantage of growth opportunities.

Keep track

Do a cash-flow projection to ensure you can always run your business and repay your debt. Constantly and closely monitor:

  • Operating expenses
  • Overheads
  • Stock levels
  • Debt collections
  • Profits

Make projections / Forecast

Forecast your sales and expenses based on estimates for:

  • Cash in or receipts (sales and other income)
  • Expenses, including both fixed expenses (e.g., rent and wages) and variable expenses (e.g., advertising, bills and transports costs)
  • Monthly loan repayments
  • Outlay on stock or raw materials
  • Stock levels
  • Remaining capital
  • Set-up costs (e.g., fit-out and legal costs)

Do some cash and profit projections ranging from best- to worst-case scenario. Monitor the projections regularly to make adjustments.

Apply the 5 Finance Must-haves

Measure the health of your business with these five finance must-haves:

Gross profit margin

Gross profit
  • The average gross profit on each pound of sales before operating expenses:
  • It will depend on the industry you’re in, so it’s important to measure yourself against industry benchmarks
  • It is an excellent way of assessing the profitability of each product

Net Profit Margin

Net profit
  • The percentage profit your business makes for every pound of revenue:
  • It tells you whether you’re making a profit after covering all your costs
  • It will be partly determined by your industry ­– some retailers run high-volume, low-margin businesses, others sell a few expensive items with plenty of margin built in

Current Ratio

Current assets
Current liabilities
  • Helps measure the solvency of your business by comparing current assets (like unpaid invoices) to current liabilities (unpaid bills):
  • Ideally, your current ratio should be two or more, which means your assets are at least double your liabilities
  • If sales are growing and you have a short operating cycle, a lower number may be fine
  • If you have a long operating cycle, you may want a higher current ratio to make sure liabilities don’t get out of control

Inventory Turnover

Cost of goods sold
  • Particularly useful if you have trading stock
  • Shows how often your business’ inventory is sold and replaced in a particular period:
  • For example, if you’ve spent £200,000 on stock over the year and you keep an average of £20,000 worth of stock on hand, your inventory turnover is 10 times a year
  • As a general rule, it is better to have a higher than lower inventory turnover
  • A low turnover indicates you have a lot of money tied up in stock for
  • Too high a figure could indicate that you don’t have enough stock on hand

Return on Owner’s Equity

Net income
Owner’s equity
  • Compares your net business income to the equity you’ve invested in the business
  • It reveals how much you’re making from your investment:
  • For example, if you’ve invested £200,000 and the business is generating a net income of £100,000 a year, your return on owner’s equity is 50 per cent
  • It tends to increase over time as the business grows, especially if your personal investment remains the same
  • It’s a useful way to compare what you’ve earned from your business to what you may have earned from another investment

In my next article I will look at the role cost control and pricing plays.

If you need help with projections and financial ratios please contact us, we will be happy to help you stay on track.