Latest Articles

Business Health Check for Business Success

Posted by:

Evaluating the business performance is one of the pivotal management tasks as it identifies the potential business problems and alarms the positive and negative signs of business performance. Business owners and managers will have the credible information through the evaluation process to rectify the problem areas of business and plan future business activities for successful growth of the business.

When evaluating the business performance, it is important to understand how the business operates along with its own key drivers of business performance. When you evaluate the business performance, it is highly recommended to use the most recent financial data including recent financial reports and Business Activity Statements lodged to ATO. If you have highly reliable business software, you can easily extract the information required for the evaluation. More frequent evaluation is required if the business is undertaking a project to improve the financial health and overall business performance to guide the project under control. By doing so, business owners and managers will become more proactive in their business decision making processes with well defined road ahead.

Business evaluation 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. The non-financial key drivers could be the lead time for certain business processes or employee absenteeism rates during particular period of time.  You need to develop your own key performance indicators (KPIs) to measure the performance drivers and compare with them with others such as industry benchmark figures.

Business evaluation 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. Collecting information from interviews, physical observation, policies and procedures and financial record is essential part of this assessment stage.

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 analyse 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 analysed 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 is the most important indicators of business success.

  • Profitability
  • Cashflow, 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 analysed and clarified before looking at any casual relationships within the outcomes.

Profitability Check

The success of any business comes with profitability, and this is the managers’ the most important task. 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 The percentage of sales dollars remaining to pay overhead expenses after deducting cost of sales (Cost of Goods Sold). 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 The percentage difference between the actual cost and the 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 can be useful when comparing against industry benchmark figures. Interest and tax are excluded when comparing against benchmark as each business has different figures regardless of their business performance.
Net Profit Margin Net Profit / Total Income * 100 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) This figure tells you that how many sales much sales dollars achieved before all the expenses are covered and actual profit begins and useful to set sales targets for the business or for sales employees.

Table 1. Profitability Measures

 

Cashflow and Liquidity Check

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. 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
Cashflow Forecast N/A This provides information on future cash resources and how the cash will be applied to the business. This is integral part of business planning that indicates additional funding requirements in advance so the business owners and managers can be prepared.
Working Capital to total sales Total current assets less total current liabilities / Total sales This figure indicates how much working capital per dollar of sales the business should be maintaining. 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 This measures whether the business hold enough current assets to meet the debts level with a margin of safety, and the acceptable ratio is 2:1 generally though it varies depends on the industry.
Quick (acid) Ratio Total current assets less inventory / Total current liabilities less bank overdraft This is the best measure for liquidity. As it excludes inventory from the calculation, it shows the real liquid assets of the business.
Leverage (gearing) Ratio Total Liabilities / Total Equity * 100 This ratio shows the level of debt financing against equity to fund the assets of the business. Generally, the higher the ratio, the more difficult to get further finance.
Debt to Asset Ratio Total Liabilities /  Total Assets * 100 The portion of assets being financed by liabilities. Generally, the ratio should be below 1.

Table 2. Cashflow & Liquidity Measures

Efficiency Check

A business must 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 This indicates the number of times the stock in the business has turned over, and the lower the rate, the longer the stock is taking to turn over. 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 This measures percentage of stock on hand included in the overall assets of the business. If high rate of assets is tied up in inventory and the inventory turnover is relatively low, it could be a signal of inventory mismanagement.
Days receivables Total debtors × days in the period /  Total credit sales of days in the period This measure indicates how fast accounts from the credit sales are being collected. If this figure exceeds the trading terms of the business, it will be indications of slow paying customers and potential bad debts.
Days payables Total creditors × days in the period /  The total cost of goods sold for the period This shows how well account payables are being managed. If suppliers are being paid on average earlier than the trading terms, cashflow will be negatively impacted. The opposite case will be possible relationship damage with suppliers.
Total asset turnover Net Sales / Total Assets This measures the ability of a business to use its assets to generate sales. The lower the total asset turnover ratio, the more sluggish the business sales are. Each asset item should be separately reviewed to identify the problem areas.
Return on Assets (ROA) Net profit before tax / Total assets * 100 This ratio indicates how efficiently profits are being generated from the assets employed in the business comparing with the benchmark ratios.
Return on Equity /Investment (ROI) Net profit before tax / Total equity * 100 This could be the best indicator for business performance. This indicates how well the business efforts transferred to business returns. 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 evaluation involves both financial and non-financial analysis with steps specified above. Identifying the problem areas and rectifying them is the greastest tasks any business managers have. To get the reliable information for business evaluation, you need to keep solid financial and non-financial record process, and measuring the information may require some professional skills. If you experience inefficient business performance, therefore have poor financial result, this is a good practice to have regular business evaluation process on hand to improve your business performance. If you require extra help to identify the problems and to interpret the outcome of evaluation, please contact your accountant or professional advisor.
19

About the Author

Ben is the director of Quantum Business House with extensive knowledge and practical experiences in taxation for both corporate and individuals, accounting and business advice. His experiences from both public accounting practices and commercial side help small and medium sized businesses to run in optimized way in their finance and operations.

Discussion

  1. partypills  January 21, 2012

    Superb blog! Do you have any hints for aspiring writers? I’m hoping to start my own website soon but I’m a little lost on everything. Would you advise starting with a free platform like WordPress or go for a paid option? There are so many options out there that I’m completely confused .. Any recommendations? Kudos!

    • Ben Youn  January 23, 2012

      Hi there,

      Our website is based on WordPress. It is quite easy to maintain and upload the blog articles. We did not spend a lot of money to build this website. Please visit WordPress.org for more information.

  2. samsung 1080p hdtv  January 23, 2012

    Your writer has presented the views about this subject in a very thoughtful and detailed manner. Thank you for publishing the article and giving me something to think about on this topic. This is primo. http://www.samsung1080phdtv.net/

    • Ben Youn  January 23, 2012

      A great feedback!. Hope you successfully implement for your business.

  3. Concreters Supplies Adelaide  January 26, 2012

    {A family member referred me to this website.

    • Ben Youn  January 26, 2012

      You must have a very good business-minded family member. Please follow our twitter or join our facebook account. You will never miss a single blog articles. Or just simply subscribe our newsletter on the website.

  4. herbal drugs australia  January 27, 2012

    I think the admin of this web site is in fact working hard in favor of his site, because here every stuff is quality based data.

  5. Packaging Adelaide  January 28, 2012

    A friend referred me to your resource. Thank you for the resources.

  6. Raquel Meakin  February 6, 2012

    I’ve been surfing online more than three hours lately, yet I never found any attention-grabbing article like yours. It’s lovely price enough for me. In my view, if all website owners and bloggers made excellent content material as you probably did, the web shall be a lot more useful than ever before.

  7. Joey Teagues  February 10, 2012

    I enjoy what you guys tend to be up too. This kind of clever work and coverage! Keep up the terrific works guys I’ve included you guys to blogroll.

  8. stop smoking  February 10, 2012

    Thanks for your post. What I want to say is that when evaluating a good on the net electronics shop, look for a web site with total information on critical indicators such as the privacy statement, safety measures details, payment guidelines, and also other terms in addition to policies. Constantly take time to investigate the help along with FAQ pieces to get a much better idea of how the shop is effective, what they can do for you, and in what way you can make the most of the features.

  9. Alissa Gottula  February 10, 2012

    I appreciate your submission, previously interesting and compelling. I have found my way here through Google, I shall return another time :)

  10. Niki Spector  February 19, 2012

    You ought to take part in a contest for one of the best blogs on the internet. I’m going to recommend this web site!

  11. cystic acne  February 19, 2012

    Good blog post. I certainly appreciate this website. Keep it up!

  12. managed dedicated server  February 19, 2012

    Hello there! This article could not be written any better! Reading through this post reminds me of my previous roommate! He always kept preaching about this. I am going to send this article to him. Fairly certain he will have a very good read. Thank you for sharing!

  13. Ward Kopko  February 20, 2012

    I like how you put your words into writing. Your content is interesting to say the least. I respect your views expressed in this article.

  14. Michal Laatsch  February 21, 2012

    Usually I do not read article on blogs, but I wish to say that this write-up very forced me to try and do it! Your writing style has been surprised me. Thanks, quite nice post.

  15. Theodore Demoranville  February 24, 2012

    I simply want to tell you that I am very new to blogging and site-building and definitely liked this website. Very likely I’m going to bookmark your blog . You amazingly have superb article content. Thank you for sharing with us your web page.

  1. Partial Fill Wall Insulation  February 17, 2012