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The Key Indicators of Financial Health

“The Key Indicators of Financial Health”

Ask the right questions, closely examine the answers.

If you wake up one morning with a runny nose or an upset stomach, you know there’s a good chance that you’re coming down with a cold. But how do you detect the early symptoms that indicate your company’s financial health is deteriorating?

Ask the right questions and make sure they get answered. Think about what makes your company profitable, how you can make it more profitable and the risks to profitability. Then you can develop plans to drive up profitability.

Part of that is "forecasting surprises." The business owner should think about the worst-case scenarios: a warehouse full of unsold inventory, receivables that can’t be collected, a term loan that comes due, a major piece of machinery that must be replaced and so on. Then focus on the possible effects on your company — and responses.

Look closely at pricing, margins and costs. Can you increase prices, perhaps by introducing proprietary products or special services? Is capacity utilized well? Are investments in marketing and advertising really paying off? Are salespeople being motivated to sell higher-margin items? Do production people have the authority to make changes that will reduce costs?

Cash-flow forecasts are critical, yet many business owners focus more on profits than on cash. Similarly, they may not take a strategic approach to debt. Rather than using debt to leverage their growth, they borrow only to handle an unexpected expense.

Accounting statements are important, but they are historical. A company’s financials tell what was. Planning asks "what if," and then tries to explore different answers for the best possible outcome.

Strategic planning must be tied to an operational plan. Telling employees, "Our margins are too low," doesn’t help. Telling them they will receive a bonus for selling Product A, which has a high margin, rather than low-margin Product B, will produce results. If it’s a manufacturing problem, establish specific quality benchmarks.

Tip: Identify "key indicators of financial health" that can be easily tracked, such as margins, sales mix, number of customers, number of days receivables are outstanding and inventory levels. Then let everyone in the company know the status of these indicators on a monthly basis. When people understand that their livelihood depends on keeping these indicators healthy, they will get involved in making that happen.

Writer: Alex Auerbach interviewed Joseph Drago. As a CPA with Ernst & Young, Drago worked with fast-growing companies. Currently, he’s a strategic planning adviser in Western Springs, Ill.