Introduction – Business review and planning
In order to commence a business review and planning process there are 5 key areas which a small business operator should focus on in order to establish the current position of the business and key areas to focus on to maximise the return on your investment.
These 5 areas are:
- Profitability
- Cashflow and Liquidity
- Efficiency
- Business Planning
- External Issues and Trends
Cashflow and Liquidity and Solvency
Many businesses look at their profit and loss and assess their profitability but fail to then take into account the cashflow issues associated with their balance sheet resulting in the all too common question – "If I made all this money then where is it?"
Monitoring the cashflow and liquidity of a business is crucial to making sure that the business has the cash to meet its upcoming outgoings as well as the ability to meet its debt commitments.
Some of the most common tools for monitoring the cashflow and liquidity include:
Cashflow Forecast
A cashflow forecast is only as good as the effort put into it. A running weekly or monthly cashflow which is updated for actual transactions provides an insight into the effect on your future cash position and allows action to be taken where necessary.
If cash is tight then a weekly cashflow can assist in helping manage creditors, meet timeframes and be proactive about dealing with the issues confronting the business. It also helps identify upcoming periods when cash will be tight or where surplus cash can be either invested short term, be used to reduce debt or used to grow the business.
Current ratio (Total Current Assets/Total Current Liabilities)
This ratio is widely used as a measure of a businesses' ability to meet its due debts from its current assets (i.e. without further borrowing).
Whilst the ratios can vary between businesses and industries, a ratio greater than 1 is a must and a target of 2 is good. However a cash business (e.g. a small takeaway business) may have a lower current ratio than a manufacturer of large goods.
Quick (or Acid) ratio (Total Current Assets less Stock /Total Current Liabilities less Bank Overdraft)
This ratio focuses on real liquid assets by excluding the inventories which may take some time to realise without discounting. It provides some insight into a business' ability to meet its short term commitments if there was a disruption to its income.
Gearing (Leverage) ratio (total liabilities/total Equity x 100)
The gearing ratio is a favourite amongst lenders looking to determine the level of debt being used to fund a business. The higher this ratio is then the less likely a bank will be to advance further funds.
Debt to Asset ratio (TOTAL LIABILITIES/TOTAL ASSETS X 100)
The debt to asset ratio provides a measure of the assets being funded by debt and should be less than 1. This will indicate that the assets are sufficient to cover the level of debt. If the ratio is greater than one then this indicates the level of debt is greater than the value of the business assets.
The next article in the series will be on Efficiency.
