Analysing and Managing your Business:
Understanding and managing the financial business drivers in your income statement and balance sheet will help you to create and run a more efficient and profitable company.
Here are a few things you should do to help keep you on track:
Manage your Income Statement:
1. Compare your revenue growth with your net profit growth.
All things being equal, your net profit growth should be in line or greater than your revenue growth. When your net profit growth is greater than your revenue growth, that's good news, as it means you are running your business more profitably. However, if your net profit growth is less than your revenue growth (e.g. revenue grew by 25% while new profit only grew by 5%) this means that the business is running with a declining profit margin.
Here are some questions to ask yourself:
- Have there been any significant changes to my business in the following areas:
- Tax rate?
- Interest expenses?
- Cost of Goods Sold?
The above items may impact your business's net profit so be sure to analyze whether these significant changes are temporary or permanent. For example, the costs of goods sold may be impacted temporarily by supply shortages or permanently by a charge for obsolete inventory or shipping due to government regulations.
2. Compare your revenue growth with the Cost of Goods Sold (COGS) and your overhead growth.
Generally, it's good news when your revenue growth is greater than your COGS and overhead growth, as it means that you're doing a good job at managing your COGS and overheads. However, if COGS or overheads are growing more quickly than revenue, then focus on managing these more effectively is required. Either you are investing to handle future growth or perhaps you are losing focus on cost controls.
Managing your Balance Sheet:
3. Compare your revenue growth with your accounts receivable (AR) growth.
Your AR growth should be inline or less than your revenue growth. If your AR growth is much greater than revenue growth, then this should be investigated. For example, if revenue grew by 10% and AR grew by 50%, this means that customers are taking longer to pay you. Ultimately, this means that they're using up more of your cash and decreasing your cash flow. Here are some questions to ask yourself when your AR growth is greater than your revenue growth:
- Are there some bad receivables in my AR that I have not identified?
- Am I focusing too much of my attention on revenue growth and neglecting the management of my accounts receivables?
- Am I able to find a balance between wanting to collect my receivables quickly versus customers who want to pay their invoices later?
4. Compare your COGS growth with your inventory growth
All things being equal, inventory days growth is a balance sheet equivalent of COGS growth on the income statement side. If the positive change in inventory is greater than the positive change in COGS, it is likely the business is holding inventory at a higher level than in the past. Ask yourself:
- Is my inventory costing more?
- How much actual inventory (units) do I have?
- Is this in finished goods or raw materials
- If it's finished goods, then are sales slowing down?
- If it's raw materials, is there a specific reason?
Then you should ask yourself:
- Is the reason related to preparing inventory?
- Were too much raw materials purchased?
As you likely know, the two assets that require the most extensive management are accounts receivable and inventory. Considerable amounts of cash are required for you to properly support both. If inventory is not turned over efficiently and your subsequent accounts receivables are not collected on time, the business can suffer a significant loss of profits.
To manage your business efficiently, be sure to focus on all areas of the business and not just on sales and revenue-generation only.