Analysing Costs in Small Business.
Once you have compiled the financial report of your business, you can examine it in many different ways.
- One of the most affective theories is to calculate your financial ratios.
- Financial ratio is a comparison of two important components of business.
- They are important because they allow you to make comparisons very quickly.
- Looking at the financial ratio helps you to plan and decide whether or not certain parts of the business are healthy.
- Looking at how these ratios change over time, helps you see how business is changing over time.
- Comparing ratios to industry averages makes it easy to see if the company is performing like a typical company in the industry or if something is odd.
- Profitability ratio indicates a business’ ability to generate profit.
- Higher the revenue and lower the cost, higher is the profitability ratio.
- Return on assets, which is calculated by dividing net profit by total assets, tells you what percentage of every dollar invested in business was returned as profit.
- Leverage ratio indicates how your company uses debt.
- Debt equity ratio, calculated by dividing total liabilities with shareholder’s equity, tell you how many dollars your company has borrowed for every dollar in owner’s equity. If the ratio is high it is a signal that the company is highly leveraged, which is a bad sign.
- Interest coverage ratio calculates how much of a business’ profits goes in paying interest on debt.
- Liquidity ratio indicates the ability of a business to pay its bills.
- Running out of cash is a serious problem for small business owners, so ratios like the current ratio, which is current assets divided by current liabilities, and the quick ratio, which is current inventory divided by current liabilities, make it easy to determine how close a company is to bankruptcy or if the business is sitting on cash instead of investing money in growth or improvement.
- Efficiency ratio indicates how well a business is managing assets and liabilities. Its most common use is inventory management. Having too little in the inventory is bad, but having too much is also unadvisable. Calculate:
- the average number of days an item remains in the inventory;
- the time it takes to sell out current inventory;
- time taken to collect the cash from sales;
- time taken to implement change in production.
All of these will help you plan future investments. There are thousands of different types of financial ratios, and covering all is not possible here. Financial analysis tend to choose a small set of important ratios based on the industry. It makes no sense to calculate the inventory returns for a barber shop. Every business has s0me important ratios to calculate and consider. It’s worthwhile to do a bit of research to see what they are for your industry. Financial ratios may be used to check profit, debt, cash and efficiency, without spending too much time.
Cost Benefit Analysis
- The purpose of financial analysis is not just producing impressive looking spreadsheets.
- It is to make better decisions.
- If the diary you are examining doesn’t show changes that improve your business, you are wasting your time.
- The core of finance is to examine a potential action, by consulting they records that you have at your disposal and deciding the next step for the business.
- Cost benefit analysis is the process of examining potential changes to your business to see if the benefits outlay the cost.
- When conducting a cost benefit analysis, it is important to include cost and benefits that are purely financial.
- Non-economic costs like enjoyment can make a huge difference in deciding whether a project is worth pursuing.
- Small improvements accumulate over time.
- Before makings decisions evaluate total cost and benefits, a little evaluation will ensure you spend your money in the most effective way.
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