Thursday, September 23, 2010

Read the Story (Ch. 2)

Well, we left off last week with some questions to your business $'s and a reference to "Benchmarking" your business' key financial numbers. Benchmarking, in a nutshell, is a comparison of your financial performance versus another company's, preferably in your same or similar industry. However, let's not get the cart-before-the-horse. Let's take a little closer look at some of those pesky questions we asked in the last post.

Starting with the first question, "Do we have enough cash", what do we need to look at or calculate to figure this out or even think about a comparison in our industry? The hint is in the words "cash" and "debts",
otherwise known as assets and liabilities. Expand the cash to include current receivables and then take all of your "current liabilities"(debts to be paid in less than 1 year) from a recent Balance Sheet. Divide your Cash+Receivables by your Current Liabilities and you hopefully get a multiple instead of a decimal.

Ex:     $150,000 / $60,000 = 2.5

This is what's called the "Acid Test Ratio" or "Quick Ratio". There are a couple of other variations of this ratio, but essentially it's a measure of Liquidity of a business. Now, don't panic at this number if you run it and get a 0.35 or something below 1.0. In the current business market for some industries this may not be out of the normal industry range. Liquidity is just one measure of a business' financial prowess and should not stand on its own. However, it should be tracked and be a part of any trend analysis that you do to monitor the changes in liquidity your business experiences. The key point: simply look at it and try to understand why it is where its at. If it's too low, it could be an indicator that you don't have enough new sales happening even if your Gross Profit Margins are between 30-50%. If it's too high, it could be skewed by high, overdue receivables balances, which we all know affects cash flow and ultimately our ability to pay overhead and debts.

So, again it's just an indicator that can mean different things at different times. See, that wasn't so painful. It's amazing what a few simple calculations can begin to tell us. Now go get that balance sheet (maybe 2 or 3 different periods) and calculate your Acid Ratio so you can start running your business By the Number$.

Stay tuned for more insight...

No comments:

Post a Comment