The thought of tax time is enough to raise the stress levels of any small business owner, reviving memories of audits, receipts and paperwork.
But the end of financial year shouldn’t just be about completing your annual return and keeping the tax man happy – utilised effectively, tax time can be a great opportunity to connect with your advisor and gauge the health of your business to review what is working well and what isn’t.
Comparing income and expenses with previous years is a good place to start. However, businesses who use accounting software have access to a range of other data providing deeper analysis and greater insights into how a business is performing.
Checking the value of your average invoice
A good place to start your business health check is reviewing the volume of invoices issued every month, and their average value. It’s generally a positive sign of business growth if both are on the increase. If the number of invoices being issued is increasing but the average value shows little to no change, it could be an indication that you’re working harder for a lower return.
Re-evaluate how and which clients you service and, most importantly, your pricing structure. It might be worth considering increasing the price of the goods and services you provide.
Measuring your cashflow
Cashflow is the lifeblood of any business. Average debtor days tell you how frequently and how long it takes for you to get paid. If they are rising you may run into cashflow difficulties.
It is possible to take immediate action to rectify high average debtor days. Instead of having to hit the phones, you can use automated tools. For example, the invoice reminder function within Xero will automatically remind your customers that payment is due without you having to lift a finger. Once that’s settled, it might be worth reviewing your payment terms and consider reducing the timeframe from, for example, 30 days to 14.
Chasing up old invoices and changing your payment terms is only the beginning. Ensuring you stay cashflow positive is critical to your long-term success, and even the most profitable business can come undone when it doesn’t have enough cash coming in to pay the bills.
Check your cash surplus for the month. How does the cash received compare with your spending? Is your bank balance in a position to cover large, unexpected expenses? Arranging a line of credit as backup is worth considering to prevent any unforeseen problems.
A major trend in the service industry is to provide services at a fixed price with payment terms via automatic debit. The payment is usually made upfront before the service is provided. Changing to this model not only improves the cashflow lifecycle but can also have a major impact on the lifestyle of a business owner – imagine being able to have a holiday at Christmas without having to worry about not getting paid for the time off! It provides greater ease of mind and a more flexible work-life balance.
Evaluating the costs of running your business
Evaluating business costs regularly as your company grows will help you get a good gauge of whether your expenditure is sustainable. In the early days costs will naturally be high as you invest in equipment, stock and in marketing. In an ideal business life cycle, however, costs should decrease as your business matures.
Using automated accounting services allows expenses and direct costs to be separated and filtered, giving you visibility on your sales minus the cost of producing your goods or services – giving you your gross profit.
Spend 15 minutes a day familiarising yourself with each of the different metrics mentioned above. Understanding each component will help you gain greater insight into your business, and diagnose and address issues as early as possible. A business health check tells you what needs to improve and helps prevent problems before they happen.
Melanie Power, Head of Bookkeeping, Xero Australia