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3 Easy Ways To Check Your Financial Health

Roger Pierce is the voice of Scotiabank's Get Growing for business website. Author, speaker and columnist, Roger has become one of Canada's top small business experts by sharing what he's learned from building 12 companies.

No one likes unpleasant surprises. Running out of money is one of them.

Annual financial statements will certainly help you and your team to monitor the long-term health of your company from year to year. However, it's equally important to monitor financial performance at regular intervals throughout the year.

For example, a problem identified and corrected in your second quarter can improve your entire fiscal period.

Keeping track of a few key numbers in your business can help you to avoid financial problems and embrace business opportunities. Check your financial health in these three areas:

1. Liquidity

More money outgoing than incoming is always a worry for small business owners. There's no immunity from cash crisis - even the world's biggest companies can suffer a cash crunch.

Liquidity measures the ability of your business to meet its short-term debt obligations. It usually involves a comparison between current assets (e.g. cash, accounts receivable) and current liabilities (e.g. rent, payroll). A 'liquid' asset can be converted into cash easily and quickly, usually within 90 days.

For example, a business with $100,000 of current assets and $20,000 of current payables would be considered liquid, with a liquidity ratio of 5 to 1. (While it differs by industry, a healthy liquidity ratio is 2 to 1.)

2. Available credit

Credit can be used to finance growth, service debt or smooth out cash flow.  A credit facility assures the business owner the company has ready access to money when needed.

Popular credit facilities include line of credit, business credit card, account overdraft protection and term loans. Reduce your stress by setting up your credit facilities long before you encounter any cash flow challenges.

How much credit should you arrange? It depends on the size and nature of your business. Work with your accountant or Scotiabank Small Business advisor to determine an appropriate amount.

3. Cost increases

It's amazing how costs can creep up on us. We may notice when consumer products increase in cost - such as gas and groceries - yet we may not notice when our own business expenses edge higher. 

Check on your business costs by monitoring your gross profit ratio monthly. It expresses the relationship between gross profit and sales. Simply divide gross profit (difference between your revenue and your cost of goods sold) by your revenue amount.

If the ratio increases, your costs are going down. If the ratio is decreasing, your costs are escalating - prompting you to take a closer look at your expenses.

  • There could be different reasons behind cost increases. Suppliers may be charging you more than expected. Shipping costs could be rising. You may be experiencing inventory shrinkage. Discounting could be hurting your income.

Most modern accounting software can output convenient monthly reports containing the numbers you need to monitor. If you are uncomfortable reviewing those numbers, it's always best to meet with a qualified financial management expert such as your bookkeeper or accountant.

 By Roger Pierce