I have written many articles on how businesses can save money and how to invest profits efficiently. However, I have yet to discuss those of you who need help understanding your businesses finances. Oftentimes, people with talent and skills have a great product or service but lack the business skills to run their business. A large aspect of running a business is understanding finances. I’m going to discuss how to financially analyse your business so you can judge how well you are really doing. This can be the key aspect in determining whether now is the time to grow your business.

A financial analysis of you business involves reviewing financial statements such as revenues, profits, operational efficiency, capital efficiency and liquidity. In order to do a financial analysis, you need to gather your financial data including bank statements, tax returns, sales records, expense reports, salary lists etc.

Revenues

A good starting point for a financial analysis is to first determine company revenue. Revenue is simply your business income. Your revenue is your source of funds for investment in your business, paying your expenses and employees, and ultimately your profit. Calculating your change in revenue over a specific period will indicate if your business is improving or declining. This could be done on a month-month-basis (short term), year-to-year (medium term) or multi-year comparison (long term). To calculate your growth (or loss) in revenue, subtract the previous period from the current period (once the current period is over). As an example, subtract the first quarter of 2021 from the first quarter of 2022. A growth in revenue will show a positive number. A negative number will show a decline in revenue.

Besides your overall revenue, you may also be able to calculate your revenue per employee if they are equally contributing, or calculate how much each contributes as a metric of performance. This can be a significant factor in deciding whether to increase your workforce or not.

Profits

Profits indicate what funds you have after your expenses (to various degrees). Calculating a gross profit margin gives an indication of how much a change in revenue will affect your operational ability and your ability to pay your expenses. To calculate your gross profit margin, subtract the cost of goods sold from your revenue and divide the total by the revenue.

Operating Profits

The operating profit margin shows you your businesses’ ability to generate a profit without consideration of how you finance the operation. This is calculated by subtracting the cost of good sold and operating expenses from revenues and dividing the total by the revenue.

Net Profits

Finally, net profits are what is left after you subtract all your expenses from your revenue. The net is what remains indicating what amount is available for reinvestment, expansion or payment as dividends. To calculate this amount, subtract all your expenses from revenues and divide the total by the revenue. The larger the net profit, the more you could invest in a business expansion, research and development or additional employees.

Other important financial ratios to consider:

A calculation of inventory turnover is a good metric of stock handling where a high turnover means you have good inventory handling. A high turnover of stock means it doesn't spend long in your possession before being sold. This is beneficial for efficient use of space and can reduce losses in the case of products with a limited lifetime. However, sometimes purchasing in larger quantities can reduce delivery costs so inventory turnover is not always a benefit and can be dependent on the business type or product.

Coverage Ratio

The coverage ratio is the company’s ability to cover its financial obligations of debts and financial commitments. A high ratio shows a high ability to cover its obligations and low ratio indicates a lack of ability. There are multiple types of coverage ratio which apply depending on the type of financial obligations a company has such as interest debt or asset debt or both.

Debt-to-Equity Ratio

The debt-to-equity ratio is the ratio of debt to equity that the company uses to finance its operations. It is a measure of how much debt a company has relative to its value of assets net of liabilities. To calculate this ratio, divide the total liabilities by the total shareholder/company equity giving a cost of debt per dollar of equity. This is an important factor in the sale of businesses.

Financial Metrics

Financial metrics are the most accurate method of tracking a business’ growth or decline. Don’t be deceived because no single metric tells the whole picture. As an example, a growth in revenue can be absorbed by a reduction in the debt to equity ratio so multiple metrics are required to get an accurate picture of how your business is performing. It can be overwhelming but if you find yourself drowning in ratios and numbers, don’t be afraid to hire a professional such as an accountant or a business coach with financial analysis experience.

If you are unsure how to correctly analyse your business, contact business coach David D’Silva for help with your finances or any other aspect of running your business.

A Financial Analysis of Your Business