As a small business owner, you need to do your best to get your company off the ground and compete with the top dogs. Understanding your finances is an important first step to knowing where you stand with local competitors. Funding for your small business can come from numerous sources, such as donations or angel investors. Not being able to assess your company’s financial needs can end up hurting your company, which can land you in debt or even bankruptcy. To prevent this from happening, take a look at these three ways to assess your small business finances.
1. Review your balance sheet, income statement, and cash flow statement
The three most important financial documents for all businesses are the balance sheet, income statement, and cash flow statement. Each of these documents provides a succinct overview of how your company is performing financially. Here’s what each document looks at:
- Balance Sheet: Your balance sheet provides a snapshot of your business’s financial situation at a specific moment in time. Balance sheets outline your assets, or what you own, and your liabilities, or what you owe. Together, you’ll be able to see your current assets and liabilities, along with your fixed assets and liabilities, along with any equity you and your partners have in the company.
- Income Statement: Your income statement provides an overview of the money you’re bringing in (income) and the money that’s going out (expenses) for a certain period of time, such as a week, month, quarter, or year. This is important because it highlights your company’s gross profit, net income, and total expenses, resulting from your sale numbers, cost of goods sold, operating income, taxes, and expenses.
- Cash Flow Statement: Your cash flow statement monitors the flow of the cash that enters and exits through your company for a particular time period. This statement looks at operating activities, financing activities, and investments, and is broken down in categories like sales, interest earned, borrowed money, payroll, debt, equipment, and so forth.
Having a solid understanding of these important financial documents is essential to assessing your business’s financial health, so make sure all numbers are accurately recorded and accounted for. To ensure you stay on top of your game, make sure you stay organized, keep receipts, and track every moving part, so you don’t miss anything. Investing in a document scanner and storing important financial information on a cloud-based server can protect these documents and prevent them from getting lost.
2. Get help from an accountant
Understanding accounting can be rather difficult if you have limited experience. For many business owners, it’s wise to seek accounting services to ensure everything is accurately recorded. Hiring a full-time accountant can be costly. However, there are plenty of alternatives, such as hiring a freelance accountant or a bookkeeper to work with you when it’s time to report, or using accounting practice management software that streamlines workflow and allows you to crunch numbers with the help of algorithms and online support.
3. Use financial ratios
There are numerous financial ratios you can use to assess and manage the finances of your small business. Some of the most common performance assessment ratios include:
- Liquidity Ratios: These ratios measure your business’s ability to repay short- and long-term debts and obligations. For example, the current ratio shows your ability to pay off short-term obligations by dividing your current assets by your current liabilities.
- Leverage Ratios: These ratios measure your company’s debt levels. For example, the debt ratio takes your total liabilities and divides it by your total assets to determine how much of your company’s assets come from debt.
- Efficiency Ratios: These ratios measure how well your small business utilizes its resources and assets. For example, the asset turnover ratio divides your net sales by total assets to evaluate your ability to generate sales from assets.
- Profitability Ratios: These ratios measure your company’s ability to generate income taking your assets, operating costs, and equity into account. For example, the gross margin ratio divides your gross profit by net sales to see how much of a profit you make after you pay your cost of goods sold.
There are numerous financial ratios that each tell a chapter of your business’s financial story. Depending on what area of your company’s finances needs to be looked at, you’ll use one of these types of financial ratios to assess the health of your small business.
Owning a business comes with a big responsibility. Your company’s finances are arguably the most important responsibility of all. Not having a grasp of your small business’s finances can lead you into debt and even force you to close your doors. With these three tips on assessing your business’s finances, you’ll be able to track important financial metrics, such as income, liabilities, assets, and more.