Financial Evaluation: Think Like an Investor

A small-business owner views an enterprise as a source of immediate income, while an investor examines the company for its long-term value. Looking at your business as an investment is certain to yield a new perspective.

Positioning your business for a long and profitable future is different than merely seeking current profits. Short-term income is the result of sales generation, but a sound long-term investment is something else. It’s a consequence of ongoing, sustainable, and rising short-term sales.

These elements can be challenging to fuse together without creating friction. Fortunately, an assessment of financial reports can allow business owners to manage their growth and build something worthy of investors. Two measures are important to consider.

Liquidity Measures

You may think that revenue and profit are the only relevant measures of business success. But an investor’s evaluation begins with the balance sheet.

This report conveys the amount of cash and the costs of assets held by the enterprise as well as how much has been borrowed. It tells you everything about company liquidity, which is how easily you can get money from your investment in the business.

Calculating key ratios using figures on the balance sheet reveals the company’s liquidity. Current ratio is the most commonly used measure. Simply divide current assets by current liabilities, and expect a result greater than one. Current assets are cash and receivables plus easily liquidated inventory. Current liabilities are all the bills you owe (accounts payable) as well as loan payments in the upcoming year.

Turnover ratios further reveal the liquidity of a business. This ratio demonstrates how quickly you collect accounts receivable, sell inventory, and pay bills.

A valuable company has high turnover ratios. It quickly collects on its invoices and promptly pays its bills. Turnover analysis reveals that accounts receivable and accounts payable are not staying on the balance sheet for extended periods, and any inventory is swiftly sold. An efficiently liquid business is not overstocked with inventory.

An accountant can assist you in identifying these ratios. Of course, this is possible only if you have up-to-date bookkeeping that provides a balance sheet along with an income statement, so don’t neglect these records.

Performance Measures

An investor would also consider the performance trends of your business. Revenue growth rate is a key factor in this performance measurement. This is calculated by dividing the change in revenue between two periods by the revenue in the oldest period.

If revenue is rising, it must be evaluated relative to turnover ratios. You have to make sure growth isn’t putting a squeeze on liquidity. This may occur when greater revenue triggers mounting costs, which are not being paid because of the time required to collect accounts receivable. Consequently, maintaining positive cash flow is crucial.

Is your business achieving a good balance of liquidity and revenue growth? This can be determined by examining the cash flow statement. This statement reveals whether your cash flow would provide a sound investment.

Consult with your accountant to ensure you remain current and accurate on each of these statements. As the biggest investor in your business, you should always know where your business stands.

Watching Your Money: The Where, How, and When

A central duty of every entrepreneur is cash management. Although making sales is essential, failure to maintain scrutiny over cash needs will chip away the rewards of growing revenue. Keeping an accurate accounting of revenue and expenses throughout the year is the crucial starting point.

Cash outflow for past expenses is a good guideline for assessing upcoming cash needs, so stay aware of your recurring monthly operating costs. Still, even with these figures, you have to dig a little deeper to construct a workable design for the future.

Keep in mind that expenses explain only partly how business cash is used. You may also have loan repayments and equipment purchases. Always know the current and upcoming debt that appears on your business balance sheet. The original costs of fixed assets, such as equipment, are also on the balance sheet, along with the amount of these costs that has been deducted as depreciation. As these assets become fully depreciated, it’s likely that replacement costs loom on the horizon.

After determining the full amount of your cash needs over the next three to six months, identify how much revenue you anticipate. Never assume you will be paid when expected. Add a buffer of one more month past the normal due date of your receivables. More revenue is earned as your business grows, but the payments will tend to arrive later. Meanwhile, your rising operating costs must be paid while you’re waiting to collect income.

If cash shortages occur, you may need to seek borrowing channels or ask some clients for retainers as your business builds.