January 1st hasn’t always been when we mark the start of the New Year. Prior to 1752 when Great Britain adopted the Gregorian calendar, New Year was celebrated in the UK on March 25th.
But the old ways persist in the world of business. The start of the new tax year, April 6th, is actually the old pre-Gregorian New Year’s Day – dates shifted forward by a dozen days with the introduction of the new calendar. And to align with the tax year, it is also when lots of companies choose to mark the start of their financial year.
As we all know, the start of a new year is always an opportune moment to get your affairs in order and make plans for the next 12 months. So with that in mind, here’s a five-point health check you can carry out to see where you are ahead of the new financial year (disclaimer: this is great to do any time, not just in the spring!)
Review Financial Statements
The first port of call for a financial health check is your records. Your income statement, balance sheet, cash flow statement – these are the documents where you will find all the information you need about revenue, expenses, assets, and liabilities. A complete snapshot of where your business is financially at this moment in time, in other words. And from that, you can start to look at areas of strength and weakness, where you might have overspent or underspent in the previous year, and any areas where you can improve.
If you are a limited company, your directors are required to produce an annual financial report for shareholders anyway, so this ties in directly with that process.
If you had to pick one measure on which to judge the financial health of your business, it would be profitability. At its most fundamental, profit is the difference between revenue and expenses. A profit-making business earns more than it spends, and the basic aim is to make the difference as large as possible, either by increasing revenues or cutting costs.
It’s well worth diving into profitability a little deeper and comparing net and gross profit margins. Net profit gives you the ‘final picture’, total income minus all costs (including cost of goods, operating expenses, tax, interest etc). It’s an obvious barometer of financial health.
But gross profit, which excludes ancilliary costs like tax and operational expenses and simply takes the cost of goods away from revenue, is also a useful figure to know. A healthy gross margin tells you there is a buffer in case other costs increase (as we have all had to contend with in recent times). Too slender a gross margin leaves you vulnerable to cost hikes and gives advance warning of the need to review prices and/or supply chain efficiencies.
Examine Your Cash Flow
Even otherwise profitable companies can land in financial trouble if they don’t get their cash flow right. It’s not just a case of earning more than you spend. You need to have money coming into the business in good time to meet your own payment obligations.
It’s therefore important to review financial records not just as a static snapshot at the end of a financial year (or at any other point), but as a continuous process over time. Have there been any times when accounts have been left empty by payments going out, or when you haven’t been able to meet a payment deadline while waiting on monies owed to arrive?
These are red flags that should be examined closely, with a view to changing your own invoicing practices or renegotiating terms with suppliers.
Review Your Debt Liabilities
As a rule, businesses don’t operate purely on the surplus they generate from sales. Credit is critical to making investments in your business, which in turn drives growth. But sourcing capital also adds costs to your business in the form of debt. And if you overburden your business with debt and struggle to make payments, your credit score is knocked down, making it harder to get credit in the future. Lack of access to capital can become a vicious trap for struggling businesses, foiling attempts to make the investments they need to grow out of trouble.
It’s therefore advisable to regularly review all of your debt liabilities and prioritise being able to keep up with payments. Be cautious about adding to an already sizeable debt burden without a clear plan to either reduce other costs or boost revenue. And protect your credit score in lieu of being able to secure capital in the future.
Set Goals and Make a Plan
Finally, the overarching purpose of all of the above is to inform your strategy going forward. Based on the data, what are your priorities for the year ahead? Increasing or protecting margins? Adjusting cash flow? Consolidating debt or extending credit to make investments? Whatever they are, set achievable goals informed by financial performance up to the present.
And one final tip. Don’t feel you need to wait until the end of the next financial year to review performance. Regular ongoing analysis is far more likely to keep you on the right path.