Is Your Business Profitable? What Your Accounts Can Tell You
You might not know it but there are some important numbers in your business that can tell you a lot about the health of your company in Singapore. Yet, so often a business owner will not have the time or knowledge of accounting to make sense of their financials. This blog will provide some insight into how you can comprehend your business financials and understand how your company is doing.
What You Can Do to Determine Business Profitability and Financial Strength
1. Analyse your income statement
Being a successful business owner is an admirable goal, but it can be difficult to measure success. One way to determine if your company has the potential for growth is by first looking at your income statement. Also known as the Statement of Comprehensive Income or Statement of Profit and Loss (P&L), an income statement provides an overview of your company’s financial performance i.e. profit or loss over a period of time. The time period could be by month or quarter (for internal reporting) or by year (for external reporting).
Some important financial ratios worth monitoring include:
- Operating profit margin – This is calculated as operating profit divided by revenue. This metric measures the operating efficiency of the company i.e how well your management is able to control its operating or variable costs. A commonly used operating profit is EBITDA, which stands for Earnings Before Interest, Tax, Depreciation and Amortisation. The higher the ratio is, the more promising it will be for your company.
- Net profit margin – This is calculated as net profit divided by revenue. Net profit is the company’s bottom line after subtracting all cost from sales. In fact, this is the most important indicator of a company. Companies with low or negative net profit margin may not survive in the industry for long, so it is important for you to focus on this ratio.
2. Analyse your balance sheet
While the income statement shows the profit or loss of your company over a period of time, it is the balance sheet, also known as Statement of Financial Position, that provides a snapshot of your company’s financial position in terms of assets, liabilities and equity at a point in time.
Liquidity and solvency make up the key financial metrics that will need to be analysed together:
1. Liquidity – This metric measures your company’s ability to pay off short-term debts and financial obligations with liquid assets as they become due. Commonly used ratios include the following two, and a ratio greater than 1 is preferred:
- Current Ratio = Current Assets / Current Liabilities
- Quick Ratio = (Current Assets – Inventory – Prepayment) / Current Liabilities
2. Solvency – This is the ability of your company to meet long-term debts and financial obligations. The quickest way to assess solvency is to look at your company’s equity (equivalent to assets minus liabilities). A negative shareholder’s equity is a sign of insolvency.
3. Analyse your cash flow statement
Did you know that more than 80% of the companies that go out of business attribute their downfall to poor cash flow management? As business owners, you need to have a clear picture of your company’s current and future cash flow to stay afloat and expand.
The cash flow statement will show where your company receives and spends money. The 3 main components of a cash flow statement are cash flows from operating activities, cash flows from investing activities and cash flows from financial activities.
Consistent with the belief that ‘Cash is King’, cash flow from operating activities is a better measurement of the strength of your company than your company’s net profit. A positive cash flow from operating activities indicates your company’s ability to generate positive cash flow from its core activities. Here, your trusted accounting service provider can give you the support and advice you need to stay fiscally strong and healthy in the long run.
4. Comparison Analysis
Finally, you can perform an in-depth analysis of the company’s performance as follow:
- Compare current year numbers against prior year numbers to see how the company is performing year on year.
- Compare current year numbers against the budget to evaluate if your company has met its plan and if there is any deviation, to analyse the cause and develop an action plan. This step would also help to validate the accuracy of the forecast and improve financial planning in the coming years ahead.
Stay Ahead of the Curve
Overall, it can be useful to know all of these different metrics when assessing the performance of your own business. Alongside the help of accounting services, you can have dedicated experts at your service to understand your financial statements for you. Especially if you are starting out as an entrepreneur in Singapore, outsourcing your accounting can give you a headstart in knowing what is important for your success. With the power of running your business with confidence and clarity, you can gain a competitive edge in an increasingly complex industry. The opportunities for growth are endless when you have this key strength to rely on!