Evaluating Business Financials: What to Check
Considering these five indicators can help you prevent cash shortfalls, check the company’s financial stability, and analyse the potential return on the company’s resources.
Please note we have purposefully addressed the very basics in this short article. We see many financial metrics used across our client base depending on their size, nature and the specific industry they operate in. If you would like to discuss some of the more specific financial metrics or KPIs that might apply to your business, please contact us and we will arrange a time to discuss.
1. Net Cash Flow
Simply put, net cash flow is the difference between all incoming and outgoing funds for a specific period. Proper cash flow management allows you to understand how much operational cash needs to remain inside the business in order to meet its obligations as and when they fall due.
It’s crucial to appreciate that a business can operate quite profitably whilst simultaneously experiencing temporary cash flow challenges. Understanding the relationship between cash flow and profit inside your business is essential and something we prioritise with each of our clients.
2. Working Capital
Businesses do not become insolvent because they are not profitable.
They become insolvent because they run out of cash and can’t meet their payment obligations as and when they fall due.
Profitable, growing companies also have cash flow challenges because they need increasing amounts of working capital to support additional investment in inventories, research and development, and accounts receivable as they grow.
3. Break-Even Point (BEP)
The break-even point is the number of units required to be sold at which the company’s revenues offset all of its costs. Every unit sold after the break-even point contributes towards the company’s profit.
To calculate the break-even point, you need to know three figures: revenue, variable costs, and fixed costs. Fixed costs generally include rent, staff salaries, etc., with variable costs changing in proportion to production volumes/output. Examples of variable costs include raw materials, transportation, and utilities, which generally vary depending on the production scale.
4. Profit and Loss Statement (P&L)
Simply put, profit is the difference between a company’s income and its operating expenses.
Forecasting and the creation of an appropriate financial model can be created to understand when a business can expect to make a profit with a clear description of how long losses may be expected.
5. Balance Sheet
The balance sheet discloses three characteristics: assets (e.g., building, bank accounts, inventory), liabilities (e.g., loans, bills payable), and owners’ equity. It reflects the state of the business on the last day of income and expenses.
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