The more you know about your business, the easier it is to make the right decisions. These 4 stats will help you gain an insight into the health of your business’ finances.
Your Debtor Days
Clients paying invoices late is a problem that plagues many businesses. In fact, the Federation of Small Businesses estimates that up to 37% of small businesses experience cash flow issues as a result of invoices being paid late. If you have to pay this month’s bills before last month’s money comes in, you could easily find yourself in hot water.
There is, however, a way for your business to monitor how effective it is at collecting on invoices. Using this simple formula, you can see, on average, how long it takes for your business to collect the money it is owed in unpaid invoices.
The formula is: (Amount in cash you are owed ÷ Annual turnover) × 365
For example, if you have £300,000 worth of unpaid invoices and your company’s turnover is £1,500,000, then 1,500,000 ÷ 300,000 = 0.2. Then you multiple 365 by 0.2 to come up with 73.
This is the amount of days that it takes (on average) for you to collect an invoice payment. In comparison, the nationwide average is 71 days to collect an unpaid invoice. Knowing the time it takes to collect an invoice can help you see when you need to fight back against the issue.
We recommend that you create a plan based on the amount of days that the invoice has gone unpaid. You could, for example, send an email once the invoice is a day late, give them a phone call after it has been 1 week, or write a formal letter after a month has passed.
Your Quick Ratio
This is sometimes referred to as the “acid test”. It measures how fast you can convert your cash and liquid assets to meet your company’s liabilities.
The formula is: (Cash + Cash equivalents + Debtors) ÷ Liabilities
The minimum ratio for this is 1:1 which means that all of your cash and assets only just covers all of your liabilities. By working this out, you can gauge whether you need to increase the cash your business holds by cutting costs or if your business is operating on a healthy foundation of liquid assets.
Your Gearing Ratio
This measures how vulnerable your business is to fall behind on debt repayments if you encounter a drop in sales or if you have an unexpected large one-off payment to make. This ratio can be used to show banks if you are looking for financial backing.
To calculate your gearing ratio, follow this formula:
Debt ÷ (Debt + Equity)
An example of this is: If your business is £450,000 in debt and your equity is £400,000 then the sum would be: 450,000 ÷ (450,000 + 400,000) = 425,000 which is 53%.
Most banks would be happy with a gearing ratio of around 50%, any higher would result in them offering a higher interest rate, or perhaps not giving you financial support at all.
Your Liquidity Ratio
The liquidity ratio works in the same way as the quick ratio. The difference is that it only measures your cash against your liabilities.
This formula looks like: Cash ÷ Liabilities = Liquidity
If you have less than a 1:1 ratio, then you don’t have enough cash in order to meet your current liabilities. This will almost certainly cause your business trouble if it is allowed to persist. The higher you are above a 1:1, then the healthier your cash float is.
We Can Help
If you would like any help in monitoring your business’ finances, then our team will be more than happy to guide you through the process. Get in touch with us on 01932 704 700 or email firstname.lastname@example.org.