Business Health Check for Business Success

All businesses have weaknesses as well as strengths. If you want to sustain and grow your business, it’s vital to address these issues before they threaten your chances of long-term success. A business health check can be a key part to that process.

When evaluating business performance:

  • It is important to understand how the business operates along with its own key drivers of business performance.
  • It is highly recommended to use the most recent financial data including recent financial reports and Business Activity Statements lodged to ATO.
  • Is not necessarily limited to financial performance of the business, rather, it is highly recommended to undertake non-financial performance evaluation as this eventually impacts business financially.
  • Involves business assessments from various information sources in order to identify the true pictures of the business operations and the key drivers of the business.

Information Analysis

Once you obtained all the relevant information regarding business operations and the key business drivers, then a review of the information should be conducted to analyze below:

  • The past three years of financial statements.
  • Documented policies on key operational areas such as pricing, buying, inventory management, internal control, supply chain management, staffing etc.
  • The value stream map.
  • Employee job descriptions.
  • Compliance documents and any agreement signed for contract entered for the business.
  • Industry information. This is particularly important as the business need to be compared with industry benchmark. The information can be both financial and non-financial. This comparison will provide measurable information in the same industry.

Developing an Evaluation Model and Measures

With the information collected and analyzed in previous step, then this information should be compared with current financial and non-financial information of the business to see the trends of the business performance which is very helpful for planning the future progress of the business. The five key areas below are the most important indicators of business success.

  • Profitability
  • Cash flow, liquidity and solvency
  • Efficiency
  • Business planning, both financial and operational
  • External issues and trends

Although each of these areas are interlinked each other, it is preferred to separate each area so that the each part can be analyzed and clarified before looking at any casual relationships within the outcomes.

 

Profitability Check

Apart from ensuring your cash flow is under control, you must also regularly check your profitability. The success of any business comes with profitability. A profitable business should ensure the business operations are in line with the overall business strategy.

Measuring business profitability can be done by applying the information to various financial ratios specified below.

Measurement Formula Description
Gross Profit Margin Gross Profit / Net Sales * 100 Gross profit margin serves as the source for paying additional expenses and future savings. This analysis will assist you assessing the efficiency of pricing, stock purchasing procedures and handling as well managed stocks
Mark-Up Gross Profit / Cost of Sales * 100 It is the difference between the cost of a good or service and its selling price. It is to ensure the business sells the products covering all the costs incurred with the sales
EBIT Margin Net profit before interest and tax / Net Sales * 100 EBIT stands for Earnings Before Interest and Tax, and this measure is useful when comparing multiple companies, especially within a given industry, and also helps evaluate how a company has grown over time.
Net Profit Margin Net Profit / Total Income * 100 The profit margin tells you how much profit a company makes for every $1 it generates in revenue or sales. Unlike EBIT margin, net profit margin includes interest and tax. This is useful figure when comparing with different periods within the business.
Break-Even Analysis Overhead Expenses / 1- (cost of goods sold ÷ net sales) A calculation of the sales volume (in units) required to just cover costs.  A lower sales volume would be unprofitable and a higher volume would be profitable.  Break-even analysis focuses on the relationship between fixed cost, variable cost (and cost per unit), and selling price (or selling price per unit).

Table 1. Profitability Measures

 

Cash flow and Liquidity Check

To determine problems with a business’s liquidity a business must have enough cash to run the business, particularly to pay the bills coming in everyday and the debts the business may already have. Being profitable does not necessarily mean being liquid. A company can fail because of a shortage of cash even while profitable. A lot of businesses went out of business due to liquidity problem, and this could be a legal issue for company directors in relation to insolvency trading. Cashflow, liquidity and solvency must be regularly monitored for this reason.

Measurement Formula Description
Cash flow Forecast N/A Is a key aspect of financial management of a business, planning its future cash requirements to avoid a crisis of liquidity.
Working Capital to total sales Total current assets less total current liabilities / Total sales This figure helps explain how well the company is using its working capital. The right percentage of the working capital per sales dollars vary business by business depending on the item price and inventory turnover level.
Current Ratio Total Current Assets / Total Current Liabilities It is a financial ratio that measures whether or not a firm has enough resources to pay its debts over the next 12 months. It compares a firm’s current assets to its current liabilities.
Quick (acid) Ratio Total current assets less inventory / Total current liabilities less bank overdraft It measures the ability of a company to use its near cash or quick assets to extinguish or retire its current liabilities immediately. As it excludes inventory from the calculation, it shows the real liquid assets of the business.
Leverage (gearing) Ratio Total Liabilities / Total Equity * 100 A term describing a financial ratio that compares some form of owner’s equity (or capital) to borrowed funds. The more leverage a company has, the riskier that company may be.
Debt to Asset Ratio Total Liabilities /  Total Assets * 100 It measures the percentage of the company’s Total Assets that are financed with debt (Total Liabilities) the ratio should be below 1.

Table 2. Cashflow & Liquidity Measures

 

Efficiency Check

A business efficiency check will help you improve your profitability and ensure that it is efficiently utilising and controlling its assets and liabilities. The measures can be used for this purpose.

Measurement Formula Description
Inventory Turnover Cost of Good Sold /  Average stock held for the period It is a measure of the number of times inventory is sold or used in a time period such as a year.  This brings issues about aged and / or over (excess) stock holdings for the business resulting liquidity issue.
Total stock on hand to total assets Total stock on hand / Total assets * 100 The total stock on hand to total assets ratio measures percentage of stock on hand included in the overall assets of the business.
Days receivables Total debtors × days in the period /  Total credit sales of days in the period The average number of days a company takes to collect payments on goods sold.
Days payables Total creditors × days in the period /  The total cost of goods sold for the period A measure of the average time a company takes to pay vendors, equal to accounts payable divided by annual credit purchases times 365.
Total asset turnover Net Sales / Total Assets It is interpreted to mean that it is the amount of sales that each unit of assets generates.  That means it’s a great indication of how the business is doing.
Return on Assets (ROA) Net profit before tax / Total assets * 100 An indicator of how profitable a company is relative to its total assets. ROA gives an idea as to how efficient management is at using its assets to generate earnings.
Return on Equity /Investment (ROI) Net profit before tax / Total equity * 100 A performance measure used to evaluate the efficiency of an investment or to compare the efficiency of a number of different investments. If ROI is lower than investment returns of others (such as bank term deposit), this raises the ultimate question for the investment itself.

Table 3. Efficiency Measures

 

Conclusion

Business Health Check involves financial performance of the business and non-financial performance evaluation and will prove to be a valuable tool as you check on the health of your business. Business Health Check will also give you a few ideas and pointers as to how you might be able to further develop and otherwise address the issues existing in your business today. If you require extra help to identify the problems and to interpret the outcome of evaluation, please contact your accountant or professional adviser.