Right now, a step-by-step guide on determining if your organization is financially fit is more relevant than ever.
Knowing how to determine a company’s financial well-being is necessary for any business owner. And while this is always the case, the pandemic reminded everyone of just how vital it is to have this skill. With this in mind, we’ve compiled a guide to gauging your own company, including the specific areas that require a close look. But first…
5 Reasons Why You Need A Clear Picture Of Your Company’s Finances
- You’ll be able to make informed decisions about the direction your company is going.
- Seeing where your company falls short financially impacts how you allocate resources.
- Looking to attract investors or financing? You will need to speak to your company’s well-being.
- It will help managers better direct their teams to achieve the maximum ROI.
- Manage the financial stress that comes with being a business will be so much easier.
How To Evaluate Your Company (Disclaimer: There’s No One Way)
Every company has a unique set of goals, hurdles, and numbers, so the metrics used to determine financial status must adapt accordingly. That said, one tried-and-true method is financial statement analysis.
A financial statement is a formal record of your company’s accounting information. Think of it as a snapshot of how finances are now and a forecasting tool for strategic planning.
Financial Statement Types And Tips
Evaluating your business begins with a financial statement analysis. It’s the process of examining various financial documents to achieve a complete understanding of your company’s health. Here is a breakdown of the different analyses you can administer, starting with day-to-day bookkeeping.
What it shows: What the company owns (assets), owes (liabilities), and shareholder equity within a specified window.
Why it is important: You get a view of the company’s current performance and the data needed to sustain and grow over time.
How to write one: Begin by listing your assets (anything your company owns with quantifiable value) on the left side of a page. For example, you might list physical property like unsold inventory or non-physical property like trademarks. Next, list the liabilities (money owed to a debtor) on the right side of the page, such as credit card balances and bank loans. The third component in the balance sheet is the company’s total assets minus its total liabilities; this is called shareholder’s equity or owner’s equity. Essentially, it represents how much money shareholders would receive if you liquidated all the assets and paid off all the debt.
What it shows: Top-line revenue, i.e., how much money your company earned over a period of time.
Why it is important: In addition to learning about earnings, an income statement tells interested parties about operating expenses, depreciation, net income, and earnings per share.
How to write one: For the statement’s specified dates, list all your earnings and calculate your total revenue. Follow that up with a list of all expenses and losses as well as the total. Lastly, include the net income by subtracting total expenses and losses from total earnings.
Statement of Cash Flow
What it shows: Inflows and outflows of cash, in other words, how your company receives and spends money. It also includes the ending balance during that period.
Why it is important: It shows an organization’s ability to operate in the short and long term. Looking at one will help investors, creditors, and regulators decide if your company is in good financial standing.
How to write one: The statement lists the increase, decrease, and net cash amounts of operating activities, investing activities, and financing activities. Operating activities refer to revenue and expenses the company generates from delivering upon its goods/services. Investing activities include sales and purchases of assets, like property sold or newly acquired equipment. Finally, financing activities account for the cash flow of both debt and equity financing. The last figure factors all three sections, appearing as net increase/(decrease) in cash account.
You Have All The Figures And Documents—Now What?
To help you make sense of all the numbers, we suggest using a tool called financial ratios. Think of financial ratios as a way of understanding relationships within your raw data. You do this by taking one number from a financial statement and dividing it by another. Which numbers you select determines the kind of insight you’ll receive. Here are some examples:
- Activity Ratios: **Tells you how well your company uses its resources. Includes: Inventory turnover, receivables turnover, payables turnover, fixed asset turnover, total asset turnover.
- Leverage Ratios: Reveals the existing dependence on debt and ability to pay long-term debt. Consider applying debt ratios, debt-to-equity ratios, and interest-coverage ratios.
- Performance/Profitability Ratios: Want to tell investors about your company’s profit at various operational stages? Give them a clear idea with gross profit margin, operating profit margin, net profit margin, return on assets, and return on equity ratios.
- Valuation/Market Ratios: These figures inform you of the attractiveness of company stock. To understand how compelling an investment it is, you can examine price/earnings (P/E), price/cash flow, price/sales (P/S), and price/earnings/growth rate (PEG).
Something To Keep In Mind When Looking At Ratios
These are just a few examples of ratios that can help you better understand your company’s financial health and performance. But in the same way that a doctor considers various signs and symptoms for a diagnosis, ratios are most valuable when analyzed as a whole. Doing so can help you identify how well your company is growing or potential problems that need attention.