Evaluating the Financial Health of Your Small Business

Your small to medium-sized business is drawing an income and your bank statement reflects a sizable balance. Your business might look sustainable at-a-glance, but is it financially healthy? 

Need help with taxes or accounting? Schedule a meeting to talk with Heath Stafford, CPA.

Your small to medium-sized business is drawing an income and your bank statement reflects a sizable balance. Your business might look sustainable at-a-glance, but is it financially healthy? 

A business isn’t a business without sales and income, but financial health is what supports and makes a business thrive. 

Many business owners start out doing their own accounting and bookkeeping, but without obtaining the vital skills required to concisely evaluate the business’s financial health, making decisions that help business growth can be challenging. Compare it to throwing a dart while blindfolded – there is no way to know if you’re hitting the target.

How to Evaluate the Financial Health of a Business

You don’t have to depend upon guesswork to determine if your business is sustainable. Some basic starting points are commonly used to evaluate the health of businesses. 

At the baseline, analyzing a business’s financial health includes these tools: 

  • Balance sheet 
  • Income statement 
  • Cash flow statement
  • Financial ratio 

Balance Sheet Analyzation

The balance sheet is a statement that represents the business’s financial position at a given point in time. 

The formula behind a balance sheet is Assets = Liabilities + Equity. 

Liabilities are what the business owes today and in the future. This includes money borrowed from other sources, money owed to suppliers and other entities (accounts payable), as well as rent, tax liabilities, and payroll expenses. 

Assets include things of value that the business operates by, such as cash in the bank. Assets also include certain investments, accounts receivable, inventory and supplies, prepaid insurance, property, land, and equipment. 

Total equity is whatever remains after the liabilities have been accounted for, including any financing that the owner put into the business. 

The balance sheet can help you analyze the financial health of your business:

  • How much debt the company has compared to equity
  • What percentage of assets are concrete and what percentage comes from financial transactions
  • The length of time it takes to collect money from customers (accounts receivable)
  • The length of time it takes to repay supplies and other entities (accounts payable)
  • How long inventory is in stock before it is sold 
  • Determine liquidity (converting assets to cash)
  • Determine solvency (whether a company can meet long-term financial obligations)

Income Statement Analyzation

The income statement, sometimes called a profit and loss statement (P&L), reflects a company’s financial standing and performance over a specified time. It reports revenues from selling products or services, expenses incurred to generate revenue and manage the business, and profits earned. 

The formula behind an income statement is Revenues + Gains – Expenses + Losses = Net Income. 

The income statement can help you analyze the financial health of your business:

  • How much money the business took in during the reporting period 
  • How much money the business spent during the reporting period 
  • Gross profit from goods sold (COGS)
  • Operating income (income – operating expenses)
  • Analyze how much the revenue grew during the reporting period
  • The percentage of revenue that resulted in net profit after all expenses are subtracted

Cash Flow Statement Analyzation

The cash flow statement is considered one of the most important financial statements. It includes cash flow from operating activities, investments, and financial activities. 

Cash flow statements can vary between several methods of accounting (accrual or cash) and three formulas, but the most basic is Free Cash Flow = Net income + Depreciation/Amortization – Change in Working Capital – Capital Expenditure. 

Cash flow allows a business to meet existing financial obligations and it helps the business owner plan for the future. 

The cash flow statement can help you analyze the future health of your business:

  • Assess the current budget and compare it to past budgets to determine future cash requirements
  • Determine investment needs
  • Determine liquidity of the business 
  • Determine if cash flow has increased or decreased 
  • Analyze spending activities 
  • Determine how to pay back loans (today and in the future)
  • Analyze how to create additional cash flow (if needed)

Financial Ratio Analyzation

Financial ratios are comparison points for businesses. These ratios are comprised of numerical values from financial statements and are used to gain financial information about businesses. 

Your bucket may already be overrunning with analysis tools today (balance sheet, income statement, and cash flow statement), so we won’t add every financial ratio that we know of to this list. 

Here are seven financial ratios that can help you analyze the health of your business:

  1. Gross Profit Margin: Compares a company’s gross profit margin to its net sales. This reflects how much profit a company makes from selling its goods and services after the direct cost of goods sold is deducted from the revenue.
  2. Net Profit Margin: Net profit is the percentage of profit a company makes after all expenses have been deducted from the revenue. 
  3. Current Ratio: Consists of comparing current assets to liabilities, which determines the business’s ability to meet its short-term obligations due in the next 12 months.  
  4. Cash Ratio: Reports how much cash a business has on hand relative to total liabilities. It analyzes how a company can pay its liabilities (or a percentage of the liabilities) with cash. 
  5. Debt-to-Equity Ratio: Determines how much debt a company has in relation to how much equity it holds. A lower debt-to-equity ratio indicates that the business has fewer debt obligations.
  6. Inventory Turnover Ratio: Reports how many times the entire inventory is sold and replaced within a certain time frame, which can help determine if inventory is being sold at a profitable rate. 
  7. Return on Assets (ROA): Measures the business’s ability to use its assets to generate income by comparing net income to the company’s average total assets. 

Does Your Business Have a Financial Analyst?

Every business needs a financial analyst. 

As a business owner, you might be good at staying on top of your accounting and bookkeeping. But combine that with the task of regularly analyzing financial statements to determine the health of your business, and utilizing financial ratios to dig in deeper, you might not be able to meet the rest of your business needs. 

You might fall short somewhere. You could miss out on what you are good at, such as sales, employee relations, customer service, managing a team, marketing, and more. 

You simply cannot do it all, and if you try, you may not do everything extremely well. 

“When you have too many top priorities, you effectively have no top priorities.” – Stephen R. Covey

Hire a Tax Planner

Small business tax planning wraps around more than the act of pouring over spreadsheets to prepare for filing and paying taxes. Tax planning ensures that you know what to consider when establishing small business and personal goals. 

Tax planning is a year-round effort. It is a financial plan strategy for a business from a tax perspective. It helps a business grow. 

Our Tax Planning

Not only do we offer full service, remote accounting, bookkeeping, and financial services, but we are here to help you with your tax services, including tax planning. 

Our goal is to help you confidently grow your business and avoid accounting and tax headaches! 

Are you ready to get started today?