17/08/2016 by Pascoe Partners Accountants
But does this mean you should?
Don’t get me wrong. I’m all for small business owners getting more in tune with what’s happening in their business. But there’s one acronym you need to keep in mind: GIGO, which stands for “Garbage In, Garbage Out”.
The cloud-based programs I mentioned earlier can all provide automated data feeds direct from your bank. But while this can greatly reduce the time spent doing your bookkeeping, a data feed isn’t the end of the process. You’ll still need to reconcile your accounts regularly, though whether this means every day or every month will depend on your business.
Nor should it be the start of the process. Whatever program you’re using, you should ensure it’s set up correctly so you’re not making important decisions based solely on what’s happening with your bank accounts. Some businesses have substantial value in their inventory, and a change in stock levels can have a significant impact on their profitability.
Your accountant will help you interpret the program’s results about how your business is doing. But here are three indicators that will provide some quick answers:
1. Quick Ratio (current assets – inventories/current liabilities)
This measures the short-term liquidity of the business. Ideally, the result should be greater than one. Anything less than one means you could have a short-term funding problem.
2. Gross Margin (gross profit/sales)
This shows the percentage of every dollar of sales available to meet your business’s overheads. By deducting the direct costs, you’ll get the gross profit. Different businesses have different gross margins, and you can find out what’s appropriate for your business through industry groups or benchmarks. (Gross Margins can also vary seasonally, depending on the business.)
Tracking this ratio regularly can build an overall picture of how the business is doing. If the margin is reducing, it could be an early indicator your business is in trouble.
3. Receivable Days (debtors/sales x 365)
This shows how long it’s taking to collect the sales you make on credit. The lower the number, the healthier your business’ cash flow will be. Remember: You aren’t there to be a bank for your clients.
Of course, not knowing who your debtors are is a completely different story.
These are just some of the indicators you can keep an eye on to give your business a regular health check. But it’s always a good idea to talk to your accountant about what’s appropriate for your particular business. And if you have any doubts about how to interpret the ratios, don’t be afraid to ask.
Whatever program you use, and whatever indicators you decide to keep an eye on, make sure the data you’re using is both timely and accurate. It’s impossible to make good decisions based on bad data.
Garbage in, garbage out.