How Well Do You Really Understand Your Business’s Financial Health?
You can have a profitable-looking business and still run short of cash.
You can increase revenue while your margins quietly shrink.
You can look at a Profit and Loss Statement every month and still not know whether your business is getting financially stronger or weaker.
That’s why I believe business owners need more than financial reports. You need to understand what those reports are actually telling you about the health of your business.
Your numbers should help you answer questions, spot problems and make decisions. They shouldn’t just be something you review after the fact.
Your Financial Statements Should Tell You a Story
Your Profit and Loss Statement and Balance Sheet contain a tremendous amount of information about your business. The challenge is that most business owners weren’t trained to interpret them.
You may look at revenue, expenses and net profit each month. Those numbers matter, but they’re only part of the picture.
The bigger questions are:
- Is profitability improving or declining?
- Are expenses increasing faster than revenue?
- Do you have enough cash to comfortably operate the business?
- Are receivables taking longer to collect?
- Is debt becoming easier or harder to manage?
- Are certain products, services or customers more profitable than others?
- Are there financial trends developing that need your attention?
Those are management questions, not accounting questions. And as the owner, they’re questions you should be able to answer.
Profit Alone Doesn’t Tell You Whether Your Business Is Healthy
One of the mistakes I see business owners make is focusing almost entirely on the bottom line of the P&L.
Profit is obviously important. But a profitable business can still have serious financial problems.
You may be profitable on paper while waiting too long for customers to pay you. You may be generating more sales while producing less profit from each dollar of revenue. You may be growing quickly while putting increasing pressure on cash.
This is why financial health has to be viewed from several directions.
You need to look at profitability, cash flow, your Balance Sheet and financial ratios together. The value comes from seeing how those numbers relate to one another and how they’re changing over time.
Trends Often Tell You More Than a Single Number
A financial statement is a snapshot. A trend gives you context.
Let’s say your gross profit percentage declined slightly this month. By itself, that may not seem significant.
But what if it has declined for four consecutive months?
Now you have something worth investigating.
The same applies to accounts receivable, expenses, cash balances, inventory, debt and other financial measurements.
Looking at financial trends helps you identify changes before they become much larger problems.
That’s one of the reasons I put so much emphasis on regularly reviewing the financial health of your business rather than simply looking at reports at the end of the month or quarter.
Financial Ratios Can Be an Early Warning System
Financial ratios take information already contained in your financial statements and help put it into perspective.
They can help you evaluate areas such as liquidity, profitability, debt and operating performance.
More importantly, tracking those ratios over time can help you identify changes in the business that may not be obvious from looking at revenue or profit alone.
A ratio moving in the wrong direction doesn’t automatically mean you have a crisis. It means you have a reason to ask a question:
- Why did it change?
- What caused it?
- Is it temporary?
- Do I need to do something differently?
That’s where financial information becomes useful for running the business.
Cash Flow Deserves Its Own Attention
Profit and cash are not the same thing.
You can make a sale today and not collect the money for weeks. You can purchase inventory, make loan payments, buy equipment or cover payroll long before the revenue associated with those expenses reaches your bank account.
That’s why understanding where your cash is going and how your cash position is trending is so important.
A rolling view of the next 30, 60 and 90 days can help you think ahead rather than react when cash gets tight.
Instead of asking, “How much money is in the bank today?” you can start asking, “What is likely to happen to our cash over the next several months?”
That’s a much more useful management question.
Better Financial Visibility Leads to Better Conversations
Understanding your numbers also changes the conversations you have with the people who help you run your business.
When you meet with your accountant, advisor, banker or leadership team, you don’t have to start by trying to understand what happened three months ago.
You can walk into the conversation already knowing:
- How profitability is trending
- What your cash position looks like
- Which financial ratios deserve attention
- Where expenses or margins have changed
- Which areas of the business may need a closer look
Now the conversation can move from explaining the numbers to deciding what to do about them.
Turning Financial Data Into Information You Can Actually Use
This is exactly why Financially Fit Business exists.
Most accounting systems do an excellent job of recording transactions and producing financial statements. The harder part for many business owners is interpreting all of that information quickly enough to use it.
Financially Fit Business takes the financial data contained in your P&L and Balance Sheet and turns it into visual, understandable information, including trends, ratios and other insights into your financial health.
Instead of staring at rows of numbers and wondering what they mean, you can more quickly see what’s happening in the business and where you may need to pay attention.
The goal isn’t to give you more financial data.
You already have plenty of data.
The goal is to make the data you already have easier to understand and use.
Start Asking Better Questions About Your Business
You don’t have to become an accountant to understand the financial health of your company.
But as a business owner, you should know enough about your numbers to recognize what’s going well, what’s changing and what needs your attention.
Start with a few simple questions:
- Is my business becoming more or less profitable?
- Is my cash position getting stronger?
- Which financial trends have changed over the past several months?
- Are my key financial ratios moving in the right direction?
- Is there anything in my financial statements that I don’t understand?
The answers can help you make better decisions today and avoid unpleasant surprises tomorrow.
See Your Financial Health More Clearly
Financially Fit Business helps turn complex financial statements into clear, visual information you can use to better understand your business.
See how Financially Fit Business can help you turn your P&L and Balance Sheet into information you can actually use to run your business.
Some Frequently Asked Question
How do I know if my small business is financially healthy?
Look beyond revenue and profit. Review profitability trends, cash flow, your Balance Sheet, debt, receivables and key financial ratios together to get a more complete picture.
What financial statements should a business owner understand?
The Profit and Loss Statement and Balance Sheet are two of the most important. Understanding how they work together gives you greater insight into profitability, cash, debt and overall financial health.
Why are financial trends important for a small business?
A single number tells you what happened at one point in time. Trends help you see whether important measurements are improving or declining and may help you identify developing issues sooner.
What financial ratios should small business owners track?
Ratios related to profitability, liquidity, debt and operating performance can provide useful insight. Tracking them consistently over time is often more valuable than looking at one ratio in isolation.
What’s the difference between profit and cash flow?
Profit measures financial performance over a period of time, while cash flow reflects money actually moving into and out of the business. A company can report a profit and still experience cash shortages.