How to Know if Your Business is Doing Well? Check Your Finances

Knowing is half the battle. In business, you have to regularly measure performance to know if your strategies are working. This data gives you unique insights that will enable your business to grow and scale. So, if you are wondering if your business is doing well, look into the data. Check your books. Your financial statements contain information on sales, assets, and more, that will help you assess business performance. 

No Need for an Accounting Background, but it Helps

In this article, we will analyze financial information and make a few calculations here and there. Regardless, there is no need to fear if you do not have a background in Accounting. Since your accountant has already taken care of your books, what we will do is simply take information for these records to measure how the business is doing.

How to Know if Your Business is Doing Well? 3 Ratios to Check

Countless business ratios can help you analyze different aspects of your business. The difference between all these is in the audience. Who will be looking into the numbers—potential investors, lenders, or you, the business owner?

Since this article is about measuring performance to know if your business is doing well, our focus is on the following three ratios. Take note: if some of these terms are unfamiliar, this article on Business Terms should help.

Profitability

At its core, businesses aim to make profits. Therefore, one of the best ways to see if your business is doing well is by checking profitability. Keep in mind though that profitability is different from profit. Profits are absolute amounts, whereas profitability is relative to another value, usually revenue. 

To measure profitability, compute for your Net Profit Margin:

Net Profit Margin = Net Profit / Total Sales x 100

This ratio shows how much profit the company is generating as a factor of its sales. A higher result signifies a higher margin, and higher margins mean your business is functioning efficiently. 

For example, your Net Profit Margin is 50%. This means that for every sale, half of the amount covers the overall cost of your operations. Meanwhile, you get to keep the other half as profit. 

Of course, the example above is just that—an example. To know whether your margins are high or low, compare it with companies of similar size within the industry. You can also compare your margins from historical data, if available, to know how well your business is doing.

Liquidity

Liquidity refers to how easy it is to convert the business’ assets to cash in order to pay debts or liabilities. Cash is considered the most liquid asset because it is universally accepted. One measure to assess liquidity is through the Current Ratio. To compute, simply divide your Current Assets over Current Liabilities:

Current Ratio = Current Assets / Current Liabilities

A ratio of more than 1 shows that assets can cover the company’s liabilities. Keep in mind though that it is not advisable to keep a huge amount of current assets. Rather, it is better to use this extra capital towards running and expanding business operations.

At the end of the day, it’s all about consistency. A ratio can be exceptional for this month, but below average during the next. If you are looking to acquire additional funding, be consistent in your financial performance. This brings us to the next topic, which is Leverage.

Leverage

Acquiring additional capital is normal in the course of running a business, especially when scaling. Extra capital is usually used to purchase additional inventory, hire manpower, or invest in machinery. When doing so, business owners have three options:

1. Bootstrapping
2. Issuing shares
3. Taking a loan

Leverage measures the percentage of capital sourced from loans (debt) compared to equity that gives away a percentage of company ownership (shares). The most common way to gauge this is through the Debt-to-Equity Ratio, which is computed as follows: 

Debt-to-Equity Ratio = Total Liabilities / Total Shareholders’ Equity

A higher ratio means that the company sources its capital more from debt compared to equity. The ideal ratio differs per vertical, so it’s better to compare your result with businesses in the same industry. This will help you determine whether your company’s leverage is within healthy boundaries.

Now that you know how to check business performance, make sure to monitor these ratios regularly to know which strategies do well and which do not. Aside from the three ratios above, here are 5 Key Accounts that you should also monitor.

Learning to invest in solutions like MPM Accounting saves you time, eliminates errors, and automates processes so you can focus more on growing your business. Resources like this provide efficiency in finishing grunt work that will otherwise take essential time and energy from you and your team.

With almost 10 years’ worth of industry expertise, MPM helps companies like yours simplify their Accounting and Payroll processes, so you can focus more on scaling. Learn more about MPM Accounting below.