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As I grow my business, I have learned that one of the most valuable uses of my time as a small business CEO is to manage the financial health of my business. In other words, is my business strong? Or — heaven forbid — are we skating on such thin ice that one or two bad months could mean the end?
My goal is to have a healthy business that can withstand a few ups and downs (emphasis on the downs) and let me get a good night’s sleep. That’s my layman’s definition of a financially healthy business.
Monitoring and managing your business’s financial health involves more than simply maintaining a cushion in your bank balance. It’s more than just keeping accurate books. It is more than staying up to date on your accounts payables and not letting your accounts receivables get too stale. Those activities are important, true.
But managing your business for financial health is about taking a big picture view of your business, as interpreted through the detail of your financial statements. Sound contradictory? It’s not.
What I am talking about is understanding your financial statements, identifying which numbers matter most on those financial statements, and interpreting those numbers to make informed business decisions. In other words, you are identifying key numerical indicators that tell you how fiscally healthy your business is.
Knowledgeable finance people and savvy business owners call these key indicators “financial ratios.” By monitoring financial ratios, you can benchmark how well your business is doing compared to healthy businesses; watch for early warning signs of ill-health; and develop goals to work toward to improve in any areas of weak financial health.
The Business Owner’s Toolkit says this about financial ratios (also called business ratios):
“In order to assess how your business is doing, you’ll need more than single numbers extracted from the financial statements. Each number has to be viewed in the context of the whole picture.
The true meaning of figures from the financial statements emerges only when they are compared to other figures. Such comparisons are the essence of why business and financial ratios have been developed.
Various ratios can be established from key figures on the financial statements. These ratios are very simple to calculate — sometimes they are simply expressed in the format “x:y,” and other times they are simply one number divided by another, with the answer expressed as a percentage. However, these simple ratios can be a powerful tool because they allow you to immediately grasp the relationship expressed.
When you routinely calculate and record a group of ratios at the end of every accounting period, you can assess the performance of your business …