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by Dale Gillmore
Just as you take the time to meet with your physician annually, it’s important to step back and assess the health of your business just as often.
Knowing your company’s vital signs -- the numbers and ratios bankers and investors would use to assess its health -- is the first step in making sure you spend your time and business resources wisely. More importantly, failing to recognize any shortcomings you’re facing can have disastrous consequences.
In our Explore Package, we get to know you, your business, and your ultimate goals. Utilizing our best thinking and innovative technologies, we provide insight into the health of your business and reveal opportunities for improvement and growth, so you can move forward with certainty. The package includes:
For the purposes of this blog, we’ll cover just a portion of that package.
Here are seven key financial metrics that can help you understand your business, how you’re faring against competitors, and what areas need attention:
• Pre-tax net profit margin
• Current ratio
• Quick ratio
• Accounts payable days
• Accounts receivable days
• Inventory days
• Debt to equity ratio
Pre-tax net profit margin
Probably the most important metric, this tells how much profit you get to keep from each dollar in sales. For private companies, it is usually expressed as net profit before taxes in a given financial period divided by sales.
This number can show you how effective you’re being with expenses and if you should decrease certain expenses so that they don’t eat up as much of the revenues. The average net profit margin for private companies is around 7%, but it can vary dramatically by company and by industry.
Current ratio and quick ratio
These two metrics give you an idea of your liquidity, or how well you can meet your near-term obligations, and they are most helpful analyzed together. If the business does not have decent liquidity, then one unexpected expense could severely impact it.
Current ratio basically shows whether the assets that you can convert into cash quickly (within a year) will cover what you must pay off soon (in less than a year), and it is expressed as current assets divided by current liabilities. A ratio of less than one means you could run short of cash within the next year unless you generate additional cash.
The quick ratio shows a shorter-term view; it divides cash plus accounts receivable by current liabilities. The average private company’s quick ratio is 2.15.
Accounts payable days and accounts receivable days
These ratios help show how you’re managing the company’s cash position so that at any point in time, you have enough to cover commitments.
Accounts payable days can indicate whether you’re paying your suppliers too quickly and losing out on money you could be investing instead of distributing immediately.
What’s a good accounts payable turnover ratio? In general, higher numbers are better, but it can vary by industry pretty dramatically.
Accounts receivable days, meanwhile, can alert you when you’re not receiving payments from customers quickly enough. (It is expressed as accounts receivable divided by sales multiplied by 365 days.) Generally, lower numbers are better for accounts receivable, because it means you’re getting cash quickly. But this, too, will vary dramatically by industry.
The inventory days ratio (inventory divided by cost of goods sold, multiplied by 365 days) measures the number of days it takes to move inventory, but it is very specific to the industry. For example, restaurants’ products have a short shelf life relative to a clothing store’s merchandise. Still, lower numbers are generally better, because you want to turn over as much inventory as possible in a year.
Debt to equity ratio
Debt-equity ratio is one of the ways to measure your business's financial health. Dividing total liabilities by the owners' equity shows how much of the company's assets are tied up in debt. The higher the ratio, the more indebted the firm. Some debt/equity ratios plugin only long-term debt rather than all debt.
It is possible to grow your company by borrowing money to fuel expansion, but too much debt poses a risk. If you're expanding, but your debt ratio is too high, that's a sign your growth is fueled primarily by debt rather than substance. That's a risky strategy because companies can't sustain debt-fueled growth indefinitely without significant growth in profits.
Because all of these metrics can vary by type of industry, it’s difficult to make sense of financial ratios unless you find quality benchmark data that gives insight into businesses of similar industry, revenue size, and geographical location.
While your CPA and other advisors might be able to provide you these raw numbers and ratios, understanding their context and obtaining a deeper financial analysis is critical to understanding what’s possible for your business and what you can do to improve it -- key elements that set the stage for future success.
Give us a call to get started.
Back to Blog
by Dale Gillmore
The average transaction takes less than a year to complete, but becoming “deal ready” takes years.
Every business owner wants to receive maximum value for their business at the time of their exit. That’s a given. Unfortunately, too many owners discover they have not put enough thought into a growth strategy to achieve that value, and they’re disappointed by the offers they receive when it’s time to sell. It doesn’t have to be this way. You can adopt sound strategies and practical techniques now that will positively position your business for transition. You just need some right information first.
70 to 80 percent of businesses put on the market don’t sell (Exit Planning Institute).
We think this failure rate is largely due to unmet owner expectations -- the surprises and disappointments they face from potential buyers at the time of transition.
No two businesses or owners are exactly alike, but many of the challenges they face as they endeavor to build maximum value – and exit on their terms – are similar. In working with business owners, we continually ask them to answer these 5 questions as we seek to build value and plan for transition.
What’s my business’ actual value right now?
Identifying value is the first step because it gives business owners a baseline measurement from which to track value over time. In other words, as they work to build (and hopefully maximize) value, this baseline number is there to gauge their success. If you cannot see increasing value, how can you know if the strategies you’re implementing are working?
But, the benefits of identifying your business value don’t stop there. Business value impacts the owner’s personal life, too, a fact often missed by business brokers. If you think your business is worth $15 million, but it’s only worth $9 million, that discrepancy will seriously impact your personal estate planning decisions and post-exit lifestyle choices. Wouldn’t it be better to know the reality of your business value far in advance of a transition, while there’s still time to do something about it?
What’s my real number?
Just as important as identifying value, it’s just as critical to understand now the approximate dollar amount needed to live the post-exit lifestyle you desire.
There are many variables that go into determining your number, but basically, we’re going to want to take stock of your future obligations, goals, and dreams. The tasks we must tackle include:
How can I eliminate risk to protect my business?
Business owners face a seemingly endless list of risks: lawsuits, regulations, technology, debt, customer concentration, human and intellectual capital, business model disruption, natural disasters, safety/compliance, embezzlement, death/disability, and cybersecurity, just to name a few.
The more risk that your business bears, the less someone will be willing to pay for it. Protecting business value, therefore, entails addressing and mitigating current and potential risk-related issues (business, financial, and personal). Have you begun that process? Do you even know where to begin?
How can I build value – in every way?
Building value is a necessary step for every business owner regardless of circumstances. Why?
When we talk about value, we’re really talking about two kinds of value: tangible and intangible. Tangible value is the “easy to see” stuff -- plant and building improvements, systems upgrades, marketing, and so on. Intangible value is everything else that matters: human capital, customer capital, structural capital, and social capital. When it comes to valuing a business, intangible value just as important as tangible value. You’re wise to focus on building both.
Which transition option is best for me?
Again, every business is different. No single transition option fits the needs of every business owner. If someone is trying to sell you an “out of the box” approach to transition, keep moving.
From family/intergenerational transfers to management buyouts, sales to existing partners, third-party sales and even liquidations, there are lots of roads to consider.
Our passion at Quest is to educate clients on the options available to them so that they make the best decision -- a decision which can only be made by weighing each transition option against individual business, financial, and personal goals. It's just what we do. Is your current transition advisor asking guiding you in this way?
If you have questions about maximizing the value of your business and/or need help aligning your personal and business goals, please reach out. While we advocate doing this years in advance of a planned transition, we can successfully navigate you through a transition when emergencies arise. Just give us a call.