Here's how to evaluate your business's financial health using your financial reports.
The second quarter of the year is a prime time for small businesses to conduct a financial health checkup. A mid-year review allows owners to track progress, identify deficiencies and adjust spending as required.
How do you diagnose your business's financial health? Knowing what to look for – or better yet, where to look – can be overwhelming. Let me help you sort through the sea of numbers that is your financial statement and offer a crash course of sorts. Here are the three main financial statements you need and an explanation of what critical information each reveals about your business's overall health.
1. Balance sheet
This report shows your financial position at a specific moment in time. With the rule of thumb that assets equal liabilities and equity, this is a good test to see if your numbers really do add up. A balance sheet also helps you determine net worth, which is the difference between what you own and what you owe. To calculate net worth, subtract total liabilities from total assets. Another benefit of a balance sheet is that it allows you to assess two other key performance metrics: debt and liquidity.
Debt. How successful are you at keeping your debt manageable? By dividing total debt by total assets, you can see the portion of your assets that are funded by debt. With any business, you may need to borrow money to make money; however, you don't want to owe more than you can repay. This may be a good time to consider implementing tighter spending practices or debt reduction strategies.
Liquidity. How quickly can your assets be bought or sold? An asset can vary anywhere between money on hand to real estate, making it challenging to truly understand your business's financial state. Some companies can be asset-rich, but cash-poor. Therefore, it is crucial to have sufficient liquid assets to cover any short-term cash needs.
Editor's note: Looking for the right accounting software for your business? Fill out the below questionnaire to have our vendor partners contact you about your needs.
2. Income statement
An income statement tallies up revenue against expenses during a given time period to help you calculate gross profit, operating income, and most importantly, net income.
Profitability. What is your bottom line? Net income is the dollar amount your business is left with after paying off expenses. This is an ideal time to analyze how much you've earned compared to sales forecasts as well as how much you've spent compared to what was budgeted.
3. Cash flow statement
This statement helps to monitor how your business moves money around. It tracks operating, investing and financing activities to show where you're bringing in cash and where you're spending it. This valuable insight can help you better manage your finances and make sound business decisions.
Cash flow. How much money do you have on hand? Having a positive cash flow is a great indicator of your business's financial health, as it means you have funds left over to reinvest in the business. This sum is primarily used towards buying, maintaining or improving your fixed assets. If you still have money after accounting for capital expenditures, you have free cash flow. This metric signifies that you're in good shape to grow and develop your business further.
Are you aligned with this year's budget?
Now that you are aware of your financial status, you can see where you currently stand compared to last year's projections. Refer to your budget and pinpoint where your numbers are adding up, surpassing or lagging. Use this information to start planning for next year's budget.
Make any necessary adjustments
The start of Q3 is an optimal time to readjust spending and strategize to boost performance until year's end. Are you outperforming or underperforming? If you're below, think about revising your budget and cutting costs; this could be done, for example, by allocating less money to marketing, reducing production costs or optimizing resources.
On the other hand, if you have extra money in your pocket, consider reinvesting it in other areas of the business. You may want to put dollars in a marketing push for the second half of the year, open up another location, franchise or hire additional personnel.
Let's face it; we're not all financial experts. Having a little help with your accounting can go a long way to better manage and monitor your business's health. Consider purchasing online software to help streamline the bookkeeping process and organize financial reports. Or, work with a business accountant for additional support; they can be a great resource in helping you get your finances in order and can also recommend ways to drive your business forward.