Your Business’ Financial Health Check for the 2021 Financial Year
In the midst of the global health and economic crisis, there’s never been a more important time to ensure your business finances are healthy.
The COVID-19 pandemic has placed an unprecedented strain on the wallets and bank accounts of millions of individuals and their businesses.
Tens of millions of job losses. Savings tapped into. Business closing down. It’s been predicted that insolvencies around the world will surge by 25% this year, and 13% in 2022. The Australian Tax Office has already indicated that they’ll be pursuing debts once businesses get their last JobKeeper payments.
So without a financial health check, it doesn’t matter how much you cut your spending. Far too often, we see business owners getting their liquidity, solvency and profitability ratios wrong – and it causes a significant amount of (preventable) stress and disruption.
As we enter into the 2021-2022 financial year, we’ve put together the ultimate business financial health check list you can use to assess whether your company is on the right track with its money. Your business’ financial health check involves looking at:
- Operational efficiency
- Profit + Return on Investment
- Sales pipeline
- Long-term goals
- Look at your liquidityLiquidity refers to the amount of cash (and assets that can easily be converted to cash) owned by your business which it can use to meet any short-term debts.Current assets ÷ current liabilities = liquidityIt’s one of the most important factors in assessing your business’ financial health, because you can’t achieve long-term growth if you’re suffering unmanageable short-term liabilities.There are two primary ways of measuring your business’ liquidity – the current ratio and the so-called ‘quick’ ratio. We generally recommend the quick ratio.
The current ratio refers to the ratio used to determine your debts due within the year, taking into account your ‘current’ assets and liabilities. If your ratio is lower than the average for your industry, that indicates your business is financial unhealthy (and at the risk of seeing red).
The quick ratio (sometimes known as the “acid test”) refers to a quicker test that only takes into account your most liquid assets, which means excluding long-term debt from your liabilities. It is typically a more conservative ratio but also also the more practical look at your financial situation (as it can show whether you’re actually able to meet your financial obligations from your more readily available assets).
If your ‘quick’ ratio is less than 1.0, your business is financially unhealthy (as your current liabilities are higher than your current assets).
- Review your solvency
Solvency is similar to liquidity, but it doesn’t just look at your business’ financial health in the short-term.It’s another critical factor in your business’ financial health because it assesses whether your operations can be feasibly managed in the long-term.It’s also critical to ensure that – if you’re business is insolvent – that you’re not trading. Directors of companies have a duty not to trade while insolvent, and can face significant penalties if they do.Solvency involves looking at your company’s debt obligations on a regular basis, taking into account any long-term debt you have comparing it to your assets and equity.You can determine your solvency by assessing your debt-to-equity ratio – the lower the ratio, the better.This is a good chance to look at your cash flow, which must remain positive if your business is to remain viable. It’s also a good chance to look at your debts (rent, wages, credit cards, business loans, mortgages and so on). If you have multiple loans outstanding, it may even be best to consolidate your debt into a single loan to make life easier for you.
- Assess whether you’re operating efficientlyIf your business lacks operational efficiency, then it’s a sure certainty your business is financially unhealthy.This will require looking at your business’ “operating margin”, which essentially looks at how well your business is able to control ongoing costs. You would be required to look at your basic operational profit margin after deducting any variables.Logically, the more efficiently your business is running, the mote potential you have to generate revenue and profit.
- Assess your profitability (+ ROI)
Profits are your business’ end goal. Without profitability, your business will not survive in the long term (although it can still survive in the short-term).Gross profit ÷ total sales + profitabilityA useful metric to assess your company’s profitability is your net margin. This is the ratio of your net profits to your total revenue. If your margin is larger than other businesses in your industry, your business is looking healthy and set to grow.A ratio is much more effective than looking at a dollar figure amount when considering profits. You might generate a profit of half a million dollars in one year. But if that’s, say, only 0.09% of your net margin, then even a minor increase in spending could steer your business down the road to insolvency.Return on investment (ROI) is similar to your profitability, but it looks to directly calculate the amount of return you are receiving on a particular investment.To determine ROI, simply calculate the return you are receiving on an investment and divide it by the cost of your investment. You can see the result as either a ratio or a percentage.
Note that ROI is a very popular way of determining a business’ financial health, but it is not the best metric for all purposes. For example, it cannot really factor into its equation any opportunity costs missed out on or the passage of time (it might take a year, for example, to actually see any ROI on one particular investment).
- Look at your sales pipeline
Looking at your sales pipeline is one of the simplest ways to assess the financial health of your company.Look at the ‘client’ or ‘customer journey’ you are providing: from the moment your customers are strangers first learning about your business, right up until they purchase your product or service.
- Do you have any leads and how qualified are those leads? Are your leads turning away from your business at any stage of the journey?If your leads are enough to sustain your business for the next few months, chances are your business is healthy. If not, rethink your sales pipeline and your strategy to convert leads into paying clients or customers.
- Setting your goals for the next financial year
Once you’re done with looking at your ratios and your sales pipeline, it’s time to set your goals.Without setting robust financial goals and the right strategy for the next financial year, you’ll be doomed to repeat the same mistakes.Your goals can’t just be vague slogans. “Get more profits” or “Get the finances in order” won’t produce any meaningful change in your day-to-day business habits.Instead, it’ll leave you feeling disappointed that your business is not growing, meeting its financial obligations or coping with economic disruption.Your goals need to be specific – in fact, they should really be SMART Goals (an acronym standing for Specific, Measurable, Attainable, Relevant and Time-Bound).For example, rather than saying “I want the business to increase profits”, consider:
- Specific: The business will boost revenue by reducing expenditure on unnecessary software capital by 16%.
- Measurable: Sales will increase over the next six months by converting 8 qualified leads into clients.
- Attainable: The business will invest in current client relationships, promoting upsells so that the clients pay more for more valuable services.
- Relevant: The business will stop working from an office and all employees will work from home, significantly cutting overhead costs by 60% and creating much more room to increase profits.
- Time-bound: Profits will increase in six months.
To determine your SMART goals and your overall strategy, you’ll need to answer some basic questions about your business which will be answered after conducting a comprehensive financial health check.
This will include questions such as whether your growth and profitability are feasible and if you’re truly satisfying your clients. Also consider if any opportunities are lying around for growth, and how your business can take full advantage of them.
Final tip: use a professional accountant.
While many business owners do their best to ensure the financial health of their company, it can often get overwhelming and end up making their lives much, much harder.
If this sounds like you and your business, we strongly recommend engaging a professional accountant to comprehensively conduct your financial health check so that you’re ready to conquer your goals for the 2021-2022 financial year.
Here at 2account, we’re specialist business accountants that take all your accounting stress out of the picture, so you can focus on growing your business.
We bring creativity, freshness and out-of-box thinking to your company so that you can have complete confidence that your business is financially healthy and on the road to success.
Get in touch with us today for your comprehensive business financial health check.
Disclaimer: Nothing on this page constitutes legal or financial advice. The information may be incomplete and abridged. Everyone’s financial circumstances are different, hence the need to consult a professional. Get in touch with a professional accountant or legal advisor to determine what’s right for your individual circumstances.