Make the first of each year the time to review your company's performance
by Dan Taylor - EVP / Northern Region, Scott Valley Bank
When I was a young banker, I worked with what we believed to be a very successful business. In reviewing and comparing the company’s financial trends over a 5-year period, the financial statements showed steady revenue growth and stable operating expenses, but declining profitability. I sat with the company owner and asked him about my observations. At first, he was taken aback as the 5-year sales growth rate was excellent. He stated, “Profit is a function of sales growth. Sales are strong, so that equates to profits.” After weeks of discussion, we revealed that his Cost of Goods Sold was higher than the actual price point at which he sold his product. He was selling the company into failure. After his initial shock was over, we reviewed the prior 5 years’ financial statements, uncovered the increases in material costs, and made the appropriate adjustments to price. In essence, he had not fully reviewed or compared the financial statements to learn from the past to make the necessary adjustments for the future. Fortunately, the company made necessary price adjustments and as the product was highly marketable, the company is viable to this day.
The basic key to financial management is the continuous analysis of your financial statements. A regular review and comparison of past financial statements (3 to 5 years) will allow you to discover trends over a period of time, providing a true depiction of your business’s condition. Numerous financial spreadsheet programs will allow you to review a number of years of trends. These programs will take the balance sheet and income statement figures and calculate your company’s “financial ratios”, which is the information that will reveal your trends and provide the information to help you to diagnose the financial condition of your company. You can also compare your ratios with industry ratios, giving you another opportunity to see how you perform as compared to your competition.
Some key ratios are:
- Solvency or Liquidity ratios such as Current Ratio and Quick Ratio
- Safety ratios such as Debt to Equity
- Gross Profit Margin including Direct Labor Expense Ratio
- Pre-Tax Profit Margin including Personal Expense Ratio and Operating Expense Ratio
- Management ratios such as Sales to Assets, Return on Assets (ROA), Return on Equity (ROE), Inventory Turnover or Days, Accounts Receivable Turnover or Days, Accounts Payable Turnover or Days
Yogi Berra said, “You've got to be very careful if you don't know where you are going, because you might not get there”.
Back to my case story, if the business owner had reviewed these ratios and how they were trending, he would have quickly noticed declining trends in the liquidity ratios, pre-tax margins, ROA, ROE, etc. I do not remember the actual profit dollars that were left on the table by not watching historic business financial trends, but it was substantial.
At Scott Valley Bank, we have the financial tools and knowledgeable Relationship Managers to assist you in this annual exercise to maximize profitability, financial ratio analysis and the long-term sustainable viability of your company. Since the Bank only does as well as your company does, we are very interested in your success.
We invite you to come in and meet our Relationship Managers to discuss your business.