Financial Red Flags Small Business Owners Must Know

financial analysis

One of the biggest mistakes we can make for our small businesses is to go through the motions without being vigilant about certain financial red flags that might point to bankruptcy or financial failure. No matter the size of your business, it is always either progressing or regressing—it’s never just remaining stagnant. So consult with a bankruptcy or foreclosure lawyer to help protect your interests and assets, stay up-to-the-minute on your business’s ledger, and see if any of these warning signs are present.

If you truly want to protect your business, then you need to know if it’s headed for trouble before it’s too late. Here are some financial red flags you need to pay attention to prevent your business from closing up shop.

The inventory turnover is low

If your business is in retail, you already know you need to constantly have fresh inventory. Thanks to the pandemic bolstering the world’s delivery services, online stores, and advanced logistics, it’s relatively easier to sell inventory and keep tight reins on it.

Since renting out warehouse space is an additional overhead cost, owners must always ensure that inventory is properly turned over every year, especially if the goods they are selling have an expiry date. If the turnover rate is on the slower side, then it might indicate that the sales are lagging, and something in your sales and marketing strategy needs to be adjusted.

Don’t be too quick to ring the alarm, however; check first with your peer companies and compare your turnover rate against theirs to see if what you’re experiencing is an industry-wide problem instead of a company-specific one.

finances

Collection periods are taking too long

The collection period is simply the time it takes for your company to convert balances into cash flow. One sign that your business is doing well is if this number is lower because it indicates that the company is efficient at collecting payment from your consumers. However, when this number is higher, it means that your customers are not paying their bills as soon as they need to or that you are lagging a bit in sales. An even higher number might be a symptom of more serious issues.

To reduce your average collection period, here are some pointers you can try:

  • The easiest way is to enforce your company’s collection policies. If your collection terms are solid, you might only be having problems enforcing them. Train your team to be polite but firm in the collection, have them send out emails and letters if payments are late, and you can even make phone calls to customers and offer favorable and more convenient terms of payments or discounts, so they can get back on track in paying.
  • Find ways to shorten the bank processing time. Make sure your business’s accounts are using automation and other tech tools to hurry this process along, and partner with your bank or a digital payments firm to find tools that will make it more convenient for your customers to pay.

Your business is losing profitability

The following are steps to see if your small business is still profitable:

  • Use the simple formula of “revenue – expenses = profit” to calculate your business’s net profit. If the number is positive, it means your business is still turning a profit. If it’s a negative, it’s an indicator that your company is losing money. If it’s a zero, it means your business is simply breaking even.
  • Calculate your business’s gross profit margin through the formula “sales revenue – the cost of goods you sold = gross profit.” This formula will help you determine if your physical products are still profitable. If the percentage is on the higher side, it means that your company is still making a profit compared to the cost of your products.
  • Take a serious look at your business’s operating expenses. If your revenue is increasing but your profit is decreasing, it might mean that your costs are still growing. While some of these expenses may include investments to help your business grow, you need to check if these expenses are worth it, and they will only be so if they are outpacing your revenue.

It’s easy to neglect how our business is doing if it seems everything looks like it’s going well at face value, but it can’t hurt to look at the books from time to time to ensure that it remains profitable. It’s not paranoia or hypervigilance—it’s staying on top of problems before they even occur. Good luck!

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