If you’re a small business owner, it’s crucial to always have an accurate understanding of its financial health.
The long-term success of your business could depend on you having the right information at the right time, so that you can act on it in the right ways.
By their very nature, small businesses usually have less financial information available to them. Larger companies tend to have bigger budgets for their bookkeeping and accounting expenditure. Public companies even have to release their official financials to the public.
But there are some standard metrics you can use to assess the financial health of a small business. Here is our list of performance metrics we recommend using when assessing the financial health of your small business.
Profitability is one of the most important metrics to measure a small business by. Whether you’re considering buying a business, or need to assess the health of your own, profitability is key.
Put simply, profitability is a measure of the money left over after the essentials have been paid for. The profits are nothing more than the difference between the revenue and the costs of a business.
Costs can include wages for employees, the cost of buying and maintaining equipment, expenses for sales and marketing, and other similar business costs.
A small business may appear healthy – such as having a strong pipeline of orders coming in, or a rapidly growing customer base – and yet be haemorrhaging money. Other businesses may be sitting on strong fundamentals and have laid the foundations for long-term growth and success.
Profitability is the cleanest snapshot of financial health that a small business can have, and one of the most critical metrics to assess small business financial health.
Liquidity is the cash on hand. Every small business needs some cash available on hand – so that if there’s ever a stretch between accounts receivable and accounts payable, the business is covered.
This applies whether you’re looking at the current ratio or the quick ratio. The current ratio is the difference between the business’s current assets, including cash and inventory, and its current liabilities. The quick ratio is the same but it doesn’t include the inventory as part of the assets – so it narrows in on whether the business has the ability to pay for its day-to-day expenses.
As a rule of thumb, a quick ratio less than 1 indicates that the business may struggle to meet its short-term debt obligations, as its current liabilities are greater than its current assets. However, make sure you are assessing the business according to its stage of growth and its industry.
While liquidity assesses a business’s ability to meet its short-term debt obligations, solvency focusses on its long-debt debt.
Solvency is the difference between the total value of the assets and the total value of business liabilities. As long as the asset value is greater than the liabilities – in other words, if it’s more than 1 – the small business is considered solvent.
Solvency is important to look out for, because it means that the small business can meet both its long-term growth goals and its total financial obligations.
Operating or operational efficiency looks at profitability as a ratio of the operating costs. In other words, the efficiency is the amount of profit earned for the amount spent on the day-to-day running of the business.
It makes sense that a small business with a high operating efficiency is running smoothly. A small business with high operating efficiency is well-managed and cost-effective.
The best way to assess the financial health of a small business is to rely on the professionals. Here at Valles Accountants, we are a boutique accounting firm with more than 35 years of collective experience. From accounting to tax advisory, we support small business owners all across Australia.
If there’s a small business you have in mind and you need to know the ins and outs of its financial health, talk with us today. Reach out to Greg and the team at Valles Accountants to make the best-informed financial decisions for your small business.