Financial evaluation is a shudder worthy term. But evaluation provides insight into how your company performs and can’t be successfully overlooked. Ongoing evaluation helps you make better decisions in real-time and control where your money is going.
If you aren’t sure what you should be looking at, or how often, here are some financial evaluation hacks from the pros.
Monitoring cash flow is important for companies whether they’re hemorrhaging money or are seeing profits. This is one of the most important areas to monitor because it allows you to spot potential issues.
Keeping an eye on growth helps you predict when you’ll need financing for things such as more inventory or materials, equipment upgrades or expansion and more staff. If you don’t evaluate cash flow, you’ll fall short when you should be expanding. Month to month monitoring is usually enough but in case of financial hardship, changing environments, or new offerings a more frequent look makes a noticeable difference.
There are basically five categories when it comes to financial indicators:
- Growth: How are your sales and profits looking? Check this month to month to compare the numbers. Look for trends. As your business matures, you can then compare each month year over year for trends.
- Liquidity: Every week you should check to see if you have the funds available to meet short-term obligations for your monthly bills. This requires comparing the amount of debt to the cash available or anticipated.
- Leverage: At least quarterly, or ideally monthly check the books to see where you can take advantage of financing to operate better and grow. This is the best way to determine if you’re incurring debt or have equity to cover costs.
- Activity: This tracks how you are managing your assets to make sure you are being effective. Assets and employees should all generate revenue and profit when properly used.
Tracking this information will help you spot opportunities or find red flags. Your CPA/business mentor can assist you to set up this tracking and then work with you to review those results. This tool allows you to make the appropriate management decision to increase success opportunities in the business.
To manage the financial viability of your company, you need to evaluate your profitability. You can evaluate these numbers over a longer period, so they’re generally easier to manage and include:
- Net profit margin:
- This is how much you earn after taxes based on sales. You’ll want a higher profit margin as this means you are primed to tackle new opportunities.
- Operating profit margin:
- This measures earnings before interest and taxes and will vary from your net profit margin. The different results are impacted by interest and tax expenses. The number is important because it provides a clue into whether you can expand by taking on more debt or investments.
- Return on assets:
- This helps you see if you’re using your assets effectively. You divide net profit (before taxes) by total assets. Hitting the right number will vary from industry to industry but as a rule, capital-intensive industries will see a low return on assets, while service-based operations will have a high return. So, the more assets you need to operate, the higher your return on assets.
These numbers are tracked year over year or over even longer periods of time such as three to five years. A Financial Planning Business Coach can help you set up a plan to review these numbers.
Efficiency ratios are usually measured over a 3- to 5-year period. There are two areas to evaluate:
- Inventory: Your inventory ratios evaluate how you can improve efficiency with suitable investment in inventory to meet demand. These ratios evaluate how quickly the inventory sells and how effectively your working capital works related to the inventory.
- Average collection period: This number shows how long it takes customers to pay you on average. Divide receivables by total sales and multiply it by 365 to make this determination.
While evaluating financials is a pain, it helps you keep on top of trends that affect the health of your business. An Accounting Coach through our Business Compass Program can help you form these habits and provide Clarity, Control and Confidence to evaluate your financials in real-time to ensure they are working for you to meet your goals. Contact us today for a Free 30-minute Introductory Call to learn more about the program.
Visit our Entrepreneur’s Guide to Accounting for more articles like this one to help you build the right foundation for your business financials.