Just as you occasionally visit the doctor for a physical or wellness check, you should frequently conduct checkups on your home business to make sure it’s healthy and thriving.
Practical Ways to Evaluate Your Company’s Health
Much like a person’s health, a business’ health depends on hundreds of independent and interconnected elements. And while you can’t always take the time to study each variable on its own, there are some equations, metrics, and common sense guidelines you can use to get a better feel for how things are going. Let’s check out a few of them:
1. Use the EBITDA Formula
If you’re looking for a quick way to get a vague idea of how your business is doing, there are plenty of methods available to you. But if you want a comprehensive and precise way to evaluate exactly how things are going, you’ll want to use the EBITDA formula (short for “earnings before interest, taxes, depreciation, and amortization”).
“The formula posits that companies can more closely nail down long-term profitability by setting aside any expenses that can’t be traced back to core operations — specifically the interest, taxes, depreciation and amortization that comprise two-thirds of the formula’s name,” Revenued explains. “Without these so-called distractions muddying up your calculations, you should be able to get a truer sense of your ability to turn a profit.”
2. Look at Debt-to-Income Ratio
If you’ve ever applied for a home loan in your personal life, then you were probably judged based on your debt-to-income ratio. In other words, the lender wanted to know how much debt you had compared to your income.
You can also judge your small business on this metric. Simply take your total monthly recurring debt payments and divide that figure by your total gross monthly income. Ideally, you want your ratio to be below 43 to 50 percent, according to FitSmallBusiness.
3. Determine Liquidity
In your personal finances, you try to keep some of your assets liquid so that they can be used when needed. The same should be true in your business. And in order to determine just how liquid your business is, you can use any number of popular ratios.
According to Wolters Kluwer, “The most common liquidity ratios are the current ratio (which demonstrates your business’s ability to generate cash to meet short-term obligations) and the quick ratio (which resembles the current ratio except inventory is not included in your current assets).”
The current ratio compares your current assets to your current liabilities. For example, if your current assets include $100,000 in cash and $50,000 in liabilities, your current ratio is 2:1.
In the quick ratio (also known as the acid test), you take your current assets minus inventory and compare it to your current liabilities. If your current assets (minus inventory) equal $75,000 and your current liabilities are $25,000, your quick ratio is 3:1.
4. Conduct an Independent Audit
Numbers aren’t everything. They can be misleading if not used appropriately. And from a subjective point of view, you aren’t the best judge. You’re clearly biased, and this can influence how you view the health of your business.
To make sure your business passes the smell test, it’s helpful to hire an independent auditor to come in and study the financial metrics of your company. You can also hire a small business consultant to tell you how you’re performing in other nuanced areas.
If you do bring in other people, you’ll need tough skin. They’ll probably tell you some things you don’t want to hear. Take their advice with a grain of salt and be prepared to make some changes to improve your business moving forward.
Are You Tuned-In?
In order to care for the long-term health of your business and make sure it’s on the right track, you can’t just conduct periodic checkups. You need to be tuned-in all the time. On a day-to-day, week-to-week, and month-to-month basis, you should know exactly how your business is doing so that necessary tweaks and improvements can be made to optimize your company’s performance and better serve customers.
If you’re falling short in this area, it’s not too late to turn things around.
