Understanding their small business’s financial health is crucial for entrepreneurs and other stakeholders. It enables them to determine future actions that are beneficial for the company in the long term and identify areas that need improvement.
The evaluation process should be conducted periodically to ensure business owners can stay on top of their finances. Ideally, they should also consult with their accountants from time to time, leveraging these professional’s insights on the matter. It also helps to use small business accounting software or a bookkeeping app to streamline processes and minimize errors.
When evaluating their company’s financial health, there are many factors that entrepreneurs should review. Listed below are some of them.
A balance sheet is a document containing a company’s assets, liabilities, equity, and total debt at a particular period. This financial statement enables entrepreneurs to determine if their business is viable or experiencing monetary problems.
By reviewing their balance sheet, small business owners can identify their company’s total debt, liquidity, percentage of tangible and intangible assets, timeframe to receive outstanding payments and settle expenses, and period to sell on-hand inventory.
An income statement provides an overview of the business’s financial standing and performance through its expenses, revenues, and profits. This financial document can be drafted with a trial balance of specific transactions coming from two different periods.
A company’s income should be constantly monitored by entrepreneurs and placed among its priority list. Small business owners may track their income on a weekly, monthly, quarterly, or annual basis. Some even look into their daily income.
Small business owners spend on overhead costs, supplies, and other expenditures. Typically, these expenses are settled monthly or at a schedule agreed upon by the business owner and the entity to which they have a financial obligation.
Entrepreneurs must have control of their expenses to avoid overspending on unnecessary business costs. Spending more than their budget allows is often impractical and can hurt their business in the long run.
Accounts Receivable and Payable
How long a customer takes to pay their invoice also affects a small business’s financial health and the company’s relationship with the customer. Small business owners should keep track of their customer invoices, ensuring their client pays on time and refrains from taking too long to pay their bills.
When a customer takes too long to settle their payment, it can cost a small business its profits. It also adds difficulty in the remittance collection process, which can exacerbate over time. For example, a customer might keep making late payments because the company fails to send a reminder or is not strict with the deadline.
Similarly, entrepreneurs should also stay on top of their accounts payable aging. One important reason for this is that it can affect the business’s credit profile. Apart from that, it also opens opportunities to gain more profits by maximizing short payment terms suppliers offer, such as discounts.
Although the company has its income statement and balance sheet, these documents are often based on accrual accounting, meaning they might not match the actual cash flow. The cash flow statement provides information on how the business has used its cash within a given accounting timeframe.
A company’s cash flow statement is among the most relevant documents used to analyze its financial health. Evaluating their cash movement allows business owners to determine their company’s liquidity situation, cash source, cash flow generated for investments, and the increase or decrease of their overall cash flow.
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