How healthy is your business? You may know how much profit you brought in last quarter or last year, but is that all you need to know?
Most business owners look to their profit and loss statement to evaluate business health, but the balance sheet is of equal importance. The balance sheet will indicate trends like whether or not working capital has increased over time. To calculate working capital, subtract current liabilities from current assets.
Assets – Liabilities = Working Capital
Working capital is the best way to evaluate the short term health of a business (i.e. that the business has enough assets to cover short term debt).
The balance sheet will also indicate whether your business is holding too much or too little inventory. Compare inventory value (from the balance sheet) to the profit and loss statement in order to gauge inventory turnover.
Cost of Goods Sold / Average Inventory = Inventory Turnover
Low inventory turnover indicates that too much inventory is being held. An extremely high turnover rate may indicate the need to hold additional inventory.
Should you purchase fixed assets? The balance sheet will reveal whether or not assets are being used sufficiently.
Net Sales / Fixed Assets = Fixed Asset Ratio
A high ration will indicate that assets are being used efficiently. A declining ratio would indicate that a business is over-invested in fixed assets.
Uncollected accounts receivable may cause cash flow problems and hinder business growth. Business owners may even look for a loan as a result. Careful analysis of the value of accounts receivable over time, the AR turnover and the aging of accounts will indicate business health and help determine if a loan is the proper course of action.
Would your balance sheet and bottom line benefit from a well-trained eye? Email David@DEKEbookkeeping.com to schedule a complimentary call.