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.