Business Loans

8 Questions to Answer When Checking on the Financial Health of Your Business

small business health checkup

8 questions to ask during a small-biz health checkup

  1. What’s my cash flow?
  2. What is my break-even point?
  3. Is my inventory balance high?
  4. What’s working?
  5. Do you have a good deal with your supplier?
  6. What do the ratios say?
  7. Am I overpaying anyone?
  8. Do you have a business succession plan in place?

Unless you’re in finance, you probably didn’t start your business because you love the paperwork that comes with it. But when you are a small-business owner, keeping tabs on the overall health of your business on a regular basis should become routine.

“It’s like going to the doctor,” said P. Simon Mahler, a certified business mentor with Score, a nonprofit that connects small-business owners with mentors. “You’ve got to do a checkup. If you don’t do a checkup you don’t know what’s going on or what’s wrong.”

A 2014 Intuit study found 81% of small-business owners handle their business’s finances themselves, but more than 40% of small-business owners consider themselves financially illiterate.

Roberto Castellón, a counselor with the Florida Small Business Development Center, says in his experience most small-business owners are so busy trying to run their operation that they only look at their records when an accountant completes their tax returns. Some owners don’t even get a chance to create quarterly statements.

“They look at it once a year in January, see their tax bill and if they have to pay, they have to pay. If they don’t, they don’t,” said Castellón. That can become a problem, he adds, because many business owners regularly pull money from the business itself to pay themselves and their workers. So they may only find out at the end of the year if they are coming up short.

Checking up on your business’s financial health isn’t just about calculating your ratios and profit margins. It’s also about looking between the numbers and answering the right questions throughout the year to see where you can improve your business.

Ideally, you should check up on your business’s health at least quarterly, says Kelli Smith, a business development officer with Grand Rapids, Mich.-based GROW.

“It’s important to monitor these numbers to not only remain competitive in the market but also to keep track of potential material inflation and increasing prices to cover rising cost,” said Smith.

But, how do you check your business financial health without wasting too much of your limited time?

Knowing what you’re looking for can help speed up the process.

With the help of a few small-business experts, we’ve compiled a list of questions that can help diagnose the health of your business.

8 questions to ask during a small-biz health checkup

1. What’s my cash flow?

Smith recommends preparing a quick cash flow statement, and looking at the statement together with a balance sheet and profit and loss statement for a more complete picture of your finances.

“Poor cash flow is a large red flag,” she said. “If your business is struggling with cash flow, it typically means you can’t collect money in a timely manner, are struggling with loan repayment or your profit margins are skewed.”

Your monthly statements can help you recognize and plan for your unique business cycles, too.

“If we know June, July and August are dead months, we know you will be short on cash, so you may want to have a line of credit open to cover expenses until your sales go back up in your profitable months,” said Castellón.

You notice right away on the cash flow statement if your business is making more cash than it’s spending, or vice versa. Seeing the business’s cash flow statement may also help you anticipate and plan future borrowing or business goals for the next period.

2. What is my break-even point?

Your break-even point is when your business’s profits are equal to its costs.

Brad Bunt, director of the North Central Texas Small Business Development Center in Corinth, Texas, says breaking even is so important, it’s one of the first things he looks at when he’s working with a start-up or new business.

“It’s very important for the company to know where it is because they need to know which goals to shoot for in their sales or their expenses,” said Bunt. “A lot of companies operate without ever knowing what their breakevens are and those are the ones I always see get into financial trouble.”

For example, if a business owner isn’t sure of his break-even point, he may not be trying to increase sales or lower expenses as he should. Knowledge, in this case, is power.

Knowing your breakeven allows you to make adjustments quickly in the direction you want the business to grow.

“Once they know what it is, then you see people really get motivated to do some selling,” said Bunt.

If your business isn’t moving inventory as it should, for example, knowing your break-even point can give you cues to make adjustments to your employees hours, save money during a down period or boost your marketing and sales tactics to increase sales.

Checking on your break-even point can also help you keep the business on track with its annual sales goals, since you’ll know your minimum sales target for the year, says Castellón.

Let’s say your breakeven is $120,000 each year, so you aim to sell $10,000 a month. If you are at only $26,000 in March — not quite on track to hit your goal — you may plan a new sales campaign for May.

“You don’t want to find out in December that instead of $120,000, you sold $85,000,” said Castellón. “Had you known by April 20th or May 6th would you have done something about it.”

3. Is my inventory balance high?

If you have inventory, you should take some time to go over your supply to see if it’s actually selling.

“What I typically find in small business is that they will have widgets they created 10 years ago and they are still sitting on the shelf,” said Mahler.

He says if you’re in that situation, the next thing you need to do is decide how you will push the inventory out, because you don’t want to sit on inventory if you don’t have to.

He suggests having a fire sale or finding a way to reutilize the unsold inventory in other products to generate income so you can put money back in the business for other things.

“Inventory is one of the biggest misunderstandings with small-business owners,” said Mahler. Usually that’s because they have no tracking system or a poor tracking system, he added.

He recommends business owners with inventory use QuickBooks, FreshBooks or another equivalent.

A final tip from Mahler to those who may be hesitant to try a tracking system: find someone who can explain it to you. He says he’s partnered small-business owners with a low-cost CPA or local financial adviser to come in and show them how to use the software.

4. What’s working?

When you’re looking at your financials, you should look to see where the pain points and red flags are, but you should also look for opportunities, Mahler advises.

He suggests asking, “How can we become that much more lean?” when looking for opportunities.

For example, look at what you spent last month or last quarter on marketing or other components of your business, and consider trimming your costs if possible.

“So many businesses just think in their mind that they have to spend ‘this amount on this’ to make money,” said Mahler. Oftentimes, that’s not true and they can trim costs somehow.

Don’t only seek for what went wrong.Take the time to look for what’s working in your business plan, too. If you notice an uptick in sales as a result of a small investment you made in marketing last quarter, you may consider putting more money toward innovative marketing strategies to meet your sales goals.

On the other hand, Mahler advises business owners who find themselves with too much inventory to backtrack and understand how they came up with the plan to sell that much inventory in the first place so you don’t make the same mistake again.

5. Do you have a good deal with your supplier?

Mahler recommends business owners always look to see where they can change suppliers and distributors.

“A lot of times people are overpaying to have their widget parts made,” Mahler said. “Don’t just assume that must be the cheapest in the world.”

Take the opportunity to shop around and see if you can find a cheaper supplier, or negotiate a better deal with the supplier you currently have. If you’re ordering from them often, for example, maybe order a larger amount for a larger discount.

Bunt says you should also rate your working relationships with suppliers. Do you have a good working relationship? Do you receive your product on time? He says if you give a poor grade to yourself, you should ask what are you doing to improve as the relationship you have may impact your business one day.

“If you ever encounter problems with being able to pay or looking at what kind of inventory to carry, you can always get better terms when you have a relationship,” said Bunt.

“When [business owners] don’t have relationships and some difficulties happen, they don’t get offered better terms, but people who have a relationship may get an extension for 30 days,” added Bunt.

6. What do the ratios say?

Ratios are important in checking where your business stands relative to the industry you’re in, and your business’s own benchmarks.

“Any time something begins to be too high or too low it needs to be investigated on the ratios,” said Bunt. For example, “If inventory turnover begins to slow and becomes consistent, immediate actions should be taken to reduce inventory even if that means cutting prices and then looking at product mix.”

A few important ratios to keep your eye on during your health check, explained by Bunt.

  • Debt-to-asset ratio: liabilities/assets — Bankers often use the debt‑to‑asset ratio to see how your assets are financed. In general, a bank will consider a lower ratio to be a good indicator of your ability to repay your debts or take on additional debt, such as a small business loan, to support new opportunities.
  • The quick ratio: assets/current liabilities — The quick ratio indicates your company’s ability to meet creditors’ immediate demands using its most liquid and current assets (quick assets). These can be cash or assets that can be converted quickly into cash, such as temporary investments and marketable securities. This ratio gives a more realistic picture of your business’s ability to repay current obligations than the current ratio, as it excludes inventories and prepaid items which you cannot obtain cash immediately.
  • Return-on-equity ratio: net income-taxes-interest/shareholders’ equity — Known as return on shareholders’ equity, this ratio measures the rate of return that shareholders receive on their investment in your business. In other words, it tells the shareholders how much the company is earning for each of their invested dollars. The return-on-equity (ROE) is also a good indicator of how effective you and your management team are in using equity to fund your operations and grow your company.
  • Inventory turnover ratio: cost of goods sold/average inventory — The inventory turnover ratio measures the number of times inventory has been turned over (sold and replaced) during the year. It is a good indicator of inventory quality (whether the inventory is obsolete or not), efficient buying practices and inventory management. It is calculated by dividing total purchases by average inventory in a given period.

Knowing where your ratios fall may also give you the information you need to step your game up to industry standards.

“Just like height, income is relative,” said Castellón. “What’s a lot of money is based on location, industry and company size.”

He adds crunching common ratios like the quick ratio or inventory turnover ratio can help you figure out what your operations may be costing the company in cash flow.

“If [a business] can get at least up to industry standards, guaranteed they will improve their cash flow,” says Castellón.

7. Am I overpaying anyone?

If you’re paying people, it’s important you take some time to make sure you’re paying them in accordance to your budget and the market rate in your area. Mahler says many small businesses actually overpay workers.

“A lot of small businesses think, ‘In order for me to have great talent, I have to pay more than my competition,’” said Mahler.

For example, if you’re a small business in a small town in middle Georgia, you shouldn’t pay Atlanta-area rates for a software engineer. Instead, Mahler recommends you should check market rates in your area using job search platforms like Glassdoor, Indeed or LinkedIn, and make a cost-of-living adjustment accordingly.

8. Do you have a business succession plan in place?

Bunt says business owners should make sure they have a backup plan for the business in place in case anything happens and they have to sell quickly.

“You never know what’s going to happen in life or with your business,” said Bunt. “And if you’re doing a business health checkup one of the last things you think about is, ‘What if I have a death in the family and have to sell quickly?’”

“People who have a backup plan do better in crisis situations.” said Bunt. Your exit plan should be part of the health checkup because it gives you good valuation of what the business is worth.

He advises looking at what you would do in the event you needed to get out of the business, hypothetically. Ask yourself:

  • Do you have a backup plan to sell this business?
  • Do you have a ballpark figure of what the selling price would be?

“Business is about making money and if it’s not making money you need to get out,” warned Bunt. He adds having a plan in place allows you to come out of an exit (hopefully) without going broke in the process.

The bottom line:

If you just can’t set some time aside to sit down and spend an hour or two doing a financial health check, look at something financial as often as you can, says Bunt. That may be as little as making sure the business account balances at the end of each day, or possibly your financial statements each quarter or every six months.

However often, you want to get a good sense of what’s going on with your business to avoid any financial hiccups or surprises later on.

 

Compare Business Loan Offers