How To Spot Trouble in Your Financials
Diagnose what's wrong with your company by zeroing in on your financials.
Published October 2004
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COMMENT ON THIS ARTICLEIn mere minutes Jerry White can usually diagnose what's wrong with a company -- often to the shock of the clueless entrepreneur. That's because White, a professor at Southern Methodist University's business school, knows where bodies tend to be buried, at least financially speaking. Here's where.
If your problem is paying the bills: This is an easy one. You need to calculate your Current Ratio:
Current Assets / Current Liabilities
Current Assets is the sum of your Cash, Accounts Receivable, Inventory, and Prepaid Insurance. Current Liabilities is the sum of your Accounts Payable and Accrued Expenses Payable. Do the math for this example [1,903,575 / 657,500 = 2.8], and you end up with a ratio of roughly 3 to 1 assets to debts. Your goal should be a healthy 2-to-1 ratio. Acme is in great shape.
If your problem is debt: As any homeowner knows, debt isn't a bad thing. But it can be risky. To see where you stand, calculate the following:
Debt-to-Assets Ratio = Total Liabilities / Total Assets
Acme is not overleveraged. Its debt ratio is 0.35 [1,152,500 / 3,333,575], which means it has a fair number of assets relative to its debt. If that number were more like 0.5, one might have reason to worry.
If your problem is slow-moving inventory: Is your warehouse a tad sleepy? To find out, figure out your Average Inventory Turnover and your Daily Turnover:
Inventory Turnover = COGS / Ending Inventory
or
Daily Average = Ending Inventory / (COGS / 365)
Acme manages to turn over goods three times [3,000,000 / 900,000] a year or every 110 days [900,000 / (3,000,000 / 365)]. So is that good or bad? Performing the same calculation for Acme for the previous two years reveals a slide. Its inventory turned five times in 2001 (every 69 days) and four times in 2002 (every 85 days). Somebody needs to kick a little butt.
If your problem is collections: Collections suggests a variety of issues from how good your product is to whether your customer service department needs help. You want to see a high Turnover Rate and a comparatively low Collection Period.
