Tips for Managing Small Businesses

Managing and operating a small business is never an easy task. However, it is this role which is at the heart of the business and is needed to ensure it runs smoothly. As said by Harvard Business lecturer, Herbert Woodward, “If a company is in difficulty, it is almost always a management problem, scarcely ever bad luck.” While it is a complex process, focusing on the concepts of financial ratios, KPI’s and cashflow can be the first step to successful management.

Financial Ratios

Financial ratios are created by using data from your financial statements to gain information about your business as well as compare it to other competitors in your industry. By analysing the data from your financial ratios, you can assess your business’ profitability, liquidity, operating efficiency and leverage.

Ratios are simply a measure of relationship between two or more components of a financial statement (profit & loss and balance sheet). To be effective, you should compare the results over several periods to reveal certain trends over time as well as to flag any issues.

While there are a quite a number of ratios to use, depending on the objective of your company performance measures, the most common ones are grouped into the following categories

1. Liquidity Ratios 

Liquidity refers to how easily a company can turn assets into cash to pay short-term obligations. The most common ratios here are:

• Working capital ratio: current assets/ current liability
• Quick ratio: current asset- stock/ current liability

• • Debt Ratio: Total Debt / Total Assets. The debt ratio measures the proportion of debt a company has to its total assets. A high debt ratio indicates that a company is highly leveraged.
  • Debt to equity ratio: Total Debt / Total Equity. The debt-to-equity ratio measures a company’s debt liability compared to shareholders’ equity. This ratio is important for investors because debt obligations often have a higher priority if a company goes bankrupt.

3. Efficiency Or Operations Ratios

Efficiency ratios show how effectively a company uses working capital to generate sales. 

• • Asset Turnover Ratio: Net sales / Average total assets
  • Inventory Turnover: Cost of goods sold / Average inventory
    

4. Profitability Ratios

A business’s profit is calculated as net sales less expenses. Profitability ratios measure how a company generates profits using available resources over a given period.

• Net Profit Margin= After Tax Net Profit / Net sales
  • Shows the net income generated by each dollar of sales. It measures the percentage of sales revenue retained by the company after operating expenses, interest and taxes have been paid.
• Return on Shareholders’ Equity= Net Income / Shareholders' Equity
  • Indicates the amount of after-tax profit generated for each dollar of equity. A measure of the rate of return the shareholders received on their investment.
• Coverage Ratio = Profit Before Interest and Taxes / Annual Interest and Bank Charges
  • Measures a business's capacity to generate adequate income to repay interest on its debt.
• Return On Total Assets= Income from Operations / Average Total Assets
  • Measures the efficiency of assets in generating profit

5. Market Value Ratios

Market value ratios are used to evaluate the share price of a company’s stock. Common market value ratios include the following:

• Book value per share ratio = (Shareholder’s equity – Preferred equity) / Total common shares outstanding.
  • The book value per share ratio calculates the per-share value of a company based on the equity available to shareholders.
•  Dividend yield ratio = Dividend per share / Share price
  • The dividend yield ratio measures the amount of dividends attributed to shareholders relative to the market value per share.
•  Earnings per share ratio = Net earnings / Total shares outstanding
  • The earnings per share ratio measures the amount of net income earned for each share outstanding. 
•  Price-earnings ratio = Share price / Earnings per share
  • The price-earnings ratiocompares a company’s share price to its earnings per share.

Key Performance Indicators

Within a business, there are numerous metrics that can be tracked by management teams, each with different levels of significance. These key performance indicators, or KPI’s, are used to quickly highlight the performance of the business, giving information on the areas in which the business is performing well or not so well. KPI’s, however, must not be taken in isolation as they are just an indication of where further investigation may be required to better understand why a certain level of performance is occurring, whether it be above or below the level of performance expected.

If after analysing a chosen KPI, there is lower-than-expected performance, it is necessary to delve deeper to understand and determine why this is the case. Was there a flaw in the production process which led to adverse material variances? Has the price of labour increased unexpectedly and led to higher labour costs to the organisation? Conversely, have sales volumes increased, leading to higher-than-expected revenue numbers?

If we don’t look further than the numbers, then we don’t truly understand our business and are not fully in control. Did the sales revenue increase occur because a sales rep offered a larger than planned discount and therefore made those sales unprofitable? Or has there been an unprecedented crisis in the external environment that has affected this change (e.g., health pandemic, trade wars, trade barriers etc).

It is important to remember, however, that Key Performance indicators are just that, indicators. They are only there to highlight areas where further investigation may be required, but in too many scenarios do business owners just look at the number then forget about it instead of further analysing the drivers behind the data.

In addition, the same KPI can mean different things to different organisations. For example, an organisation’s sigma score can be used to measure the number of errors per million opportunities. If a financial services organisation maintains a score which equates to 10,000 errors, it may be inconvenient to customers. However, what if it is a pharmaceutical company? Producing medicine with 10,000 errors every million doses will likely lead to patient deaths. It is thus important when comparing to KPI’s to stay within your industry for accurate and useful analysis.

Key Performance Indicators need to not only be relevant to the organisation, but also be used to drive improvements in performance in the operational aspects of the business or there is very little point in reporting on them in the first place.

The Importance of Good Cashflow Management

Here is where a business either succeeds or fails. In fact, according to a 2022 study, 82% of businesses that went under did so because of cashflow problems. Cashflow is the lifeline of every business, however we need to know how much to invest into short-term and long-term capital.

A business’s cash flow management is arguably the most important task for the financial team. This delicate balancing act can be difficult and stressful — you have to make certain you have the money needed to run your company, pay your vendors, and pay your employees, but you don’t always collect money from your customers right away.  A good business owner will be able to prioritise what needs to be paid while holding out for income.  If you’re uncertain if you’re managing your cash flow well, here are a few tips.

• Make income projections. Cashflow projections every increment of time, be it a quarter or year etc, are extremely helpful as they aid in determining how much money you’ll likely have. Of course, remember that projections are estimates not guarantees.  The market fluctuates in ways that no one can predict, and what seems like a sure thing can be a disaster. The shorter the time between each projection, the more accurate the estimations will be. You can’t make any decisions until you have an idea of how much cash you’ll have on hand.
• Also, be certain to know when money is going out. Track all your expenses and make sure you’ll be able to meet them.
• There will be times when you simply don’t have the income to pay every one of your bills, so you have to know which to prioritise. For example, you may be able to hold off on paying the office’s electric bill for a week or so, but it would be hard to justify holding out your employees’ pay checks for more than a day. By making a list of when a bill is due and how long you have to pay it, you can prolong your payments while ensuring you don’t miss any deadlines.
• Look for ways to make your business more efficient. By implementing new technology or reducing the time it takes for employees to complete their tasks, the more time they have to work on long term projects that bring in more money.  Likewise, the faster products are created, the more you have to sell.  Just don’t take shortcuts that lead to cheaply made materials or poor-quality service delivery.  That can backfire and cost you more in the long run.
• Consider asking customers to put down deposits when they make an order. This will give you at least some cash on hand to put towards expenses.
• If you’ve had inventory on the shelves for a long time, clear it out. Even though you may be taking a loss on it, it’s better to sell it for something than let it go to waste for nothing.

The name of the managerial game is return on investment or ROI. Everything you do should return to this concept as for your business to grow, so must your ROI. BY placing early but significant emphasis on aspects such as your financial ratios, KPI’s and consistent cashflow management, you are setting the business up for success.