Use Accounting Checks To Diagnose The Health Of Your Business

Running a business can be overwhelming, but that does not mean you should lose sight of your financial results. After all, it is not just passion and ideas that drive your business. Money is the fuel that keeps it going.  

Believe it or not, one of the things business owners tend to overlook is the financial health of their company. It is pretty understandable, as entrepreneurs usually focus on things they do best and are passionate about.

If you are an entrepreneur, you need to know how your business is performing for several reasons. Getting a clear picture of your company’s financial health can help you make better decisions about your business’s direction. It also gives you an idea of how you should allocate resources. If you aim to seek financing or attract investors, you need to understand your organization’s financial health.

Understanding your business’s financial health

If you are the owner or manager, you need to understand where your company stands financially to make sound judgments. If you overlook your financial health, you might fall into the trap of chasing more projects or other initiatives that do not benefit the organization at all.

There are several metrics you can use to evaluate financial health, among which is through accounting checks.

Analyzing the financial health of your business

1. Scrutinize the balance sheet

You can learn about your business’s financial position through the balance sheet. Here, you get a picture of its assets, liabilities, and equity.

The balance sheet helps you evaluate how much debt you have relative to equity, how liquid your business is, the percentage of tangible assets, how long it takes to sell inventory, and how long it takes to receive payments and pay suppliers.

2. Analyze the income statement

The income statement shows your company’s financial position and its performance over a particular period. This statement looks at revenue and expenses and can be written for any period.

It starts with earned revenue minus costs to determine the period’s gross profit. It then deducts all the other expenses to identify the earnings before interest and tax. These expenses include rent, salaries, water, electricity, and non-cash payments.

Lastly, it subtracts cash paid for tax and interest to come up with the net profit.

The income statement helps you analyze the gross profit margin, how much revenue is growing over a certain period, how much the company repays investors, and the percentage of revenue in net profit after expenses. The income statement is also where you will find out if your company can repay interest on any debt.

3. Financial ratio analysis

Financial ratios help you make sense of the figures cited in financial statements and are potent tools for figuring out your business’s overall financial health. Ratios fall under an array of categories, including profitability, valuation, solvency, liquidity, and efficiency.

Financial ratios should be measured across periods of time and against competitors to determine whether your organization is improving or deteriorating and how you are managing against your direct and indirect competitors. No single ratio is enough to evaluate your company’s overall financial health, instead, you should use a combination of ratio evaluations.

• Gross profit margin
• Net profit margin
• Current ratio
• Quick ratio
• Coverage ratio
• Debt-to-equity ratio
• Inventory turnover
• Total asset turnover
• Return on assets (ROA)
• Return on equity (ROE)

4. Evaluate the cash flow statement

The cash flow statement is among the most significant documents you can use to evaluate your company’s finances, as it brings key insights into the generation and use of cash. The cash flow statement exists to eliminate the impacts of non-cash activities and give a clearer economic picture to owners, investors, and managers.

It helps you evaluate your company’s liquidity, sources of cash, and the free cash flow your business generates that you can reinvest later on. The cash flow statement also shows trends, telling you whether your overall cash flow has increased or decreased.

Creating an accounting plan

If you are a small business owner, you should create a small business accounting plan to ensure that you have covered your bases. Here are the steps you can take.

1. Open a bank account if you haven’t yet

This sounds basic, but many new businesses mix personal finance with business accounts.  It is critical that you have a separate bank account for your business. Have both a checking and savings account.

2. Monitor your expenses

Develop a system for organizing records of your expenses. It is a vital step that lets you track your business’ growth, prepare tax returns, monitor deductible expenses, and legitimize your filings. Make it a habit to keep receipts regardless of the amount.

Pay special attention to these types of receipts.

•  Meals and entertainment. Business meetings in restaurants and coffee shops are a great way to do business, but make sure to document them. Write down the purpose of the meeting and who attended it at the back of the receipt.
• Out-of-town business travel. Your receipt will help you convince the IRS that your out-of-town activities are business-related.
• Vehicle expenses. Keep track of where, when, and why you used the vehicle, then apply it to vehicle-related costs.
• Home office receipts. Compute for what percentage of your home is utilized for business, then apply that to home-related expenses.

3. Create a bookkeeping system

Bookkeeping is the daily process of keeping track of transactions, categorizing them, and reconciling bank statements. 

4. Establish a payroll system

You should establish a payroll schedule and make sure that you are withholding taxes correctly.

5. Determine how you will collect payments

When your customers start coming in, you will have to find a way to get paid. Determine how you want to accept credit card payments and third-party processors.

6. Identify your tax obligations

There are different tax obligations, and they all depend on your company’s legal structure. If you are not employed by any company, you will claim business income on your personal tax return. Corporations are separate tax entities and are assessed separately from owners. Your profit from the corporation is taxed as a team member.

7. Compute for gross margin

To determine gross margin, you have to know the costs to manufacture your product. The discrepancy between how much you sell a product for and how much the business earns at the end of the day determines your capacity to keep the business running.

8 Find funding

It is often necessary to find external funding through investors, a credit line, or a business partner. Keep in mind that you will have to provide your balance sheet, income statement, and maybe the cash flow statement to obtain a small business loan.

However, it is necessary to ensure the figures make sense. In other words, you should calculate the ROI of the credit. Add up all the expenses you need the loan to pay for, the proposed new revenue you will receive from the loan, and the total cost of interest.

9. Hire accountants

Hiring accountants can help you get control of your finances. Accountants are probably more updated on accounting methods and tax laws than you are, which is why you need them.

10. Re-evaluate your methods from time to time.

As your company grows, you may want to consider updating your techniques, like upgrading to programs like Quickbooks instead of simple spreadsheets.

Conclusion

When you are short on time, you need an intelligent approach to managing your business finances. Using accounting checks to diagnose your business’ financial health is essential for business owners, investors, and employees. 

By following these simple accounting steps and then interpreting the data in financial statements, you can understand more about your organization’s financial health and turn insights garnered from statistics into actions that improve your business.