Business Finance Consultants

Financial Ratios – Solvency Ratios

I spoke in previous blogs about the importance of Profitability Ratios, then Efficiency Ratios, then Liquidity Ratios. Finally, in this blog, I highlight the importance of Solvency Ratios.

It’s important to not confuse Solvency with Liquidity. While both set of ratios measure the financial health of a company, they have notable differences. As previously explained, the Liquidity Ratios are used to determine a company’s ability to pay off its short-term debts (12 months and less). The Solvency Ratios measure the ability for a company to meet its long-term financial obligations.

In other words, the Liquidity Ratios measure the ability to quickly convert assets into cash, while the Solvency Ratios checks that the business owns more than it owes. The latter has a longer term emphasis. Read more

Business Finance Consulting

Financial Ratios – Liquidity Ratios

In earlier blogs, I spoke about the importance of Profitability Ratios, then Efficiency Ratios. In this blog, I highlight the importance of Liquidity Ratios.

Liquidity ratios are used to determine a company’s ability to pay off its short-terms debts. Short term means 12 months and less.

Liquidity ratios can be of enormous benefit to business owners, Directors and Managers when developing budgets. They tend also to be of great interest to lenders, Creditors, potential investors and prospective Managers and Directors when making decisions as to whether or not to join a company.

Common liquidity ratios include the Working Capital Ratio, the Current Ratio, the Quick Ratio and the Operating Cash Flow Ratio. Read more

Business Finance Consultants

Financial Ratios – Efficiency Ratios

In an earlier blog (Financial Ratios – Profitability Ratios), I spoke about the importance of Profitability Ratios. In this blog, I highlight the importance of Efficiency Ratios.

In simple terms, Efficiency Ratios measure how well companies utilise their short term assets and short term liabilities to generate income. Efficiency ratios, for example, might include the time it takes for companies to collect cash from customers, how quickly or slowly they pay their suppliers and the time it takes to convert inventory into revenue.

While Efficiency Ratios are generally used by management to help improve the company, they are also often used to inform outside investors and creditors of the operational performance of the company.

Let’s consider a couple of examples of Efficiency Ratios:

Debtor Days tells you how many days it takes for the money to reach your bank account after you have issued invoices. The lower, the better. A decrease in the ratio is good; an increase should be regarded as an alarm bell.
Debtor Days = Debtors (Net of GST) / Annual Sales x 365

Creditor Days represents the average time that a business takes to pay its Creditors. The higher, the better.
Creditor Days = Creditors (Net of GST) / Annual Cost of Goods Sold x 365 Read more

Business Finance Consulting

Financial Ratios – Profitability Ratios

A recent article in the Australian Financial Review explained that the three main reasons for business failures were: Poor Financial Management (28% of failures), poor Accounting (16%) and lack of Management experience (15%).

So Poor Financial Management is the main culprit in business failures. The Directors and the owners of a company need to monitor the financial performance of the business. Revenue, Gross Profit, Operating Profit are important elements, but they have limitations: Firstly, they vary considerably with the ups and downs of Revenue (seasonality), and secondly, an increase in Operating Profit does not always reflect good performance (if Operating Profit increases by 5% for example, while Revenue increases by 20%, it is a poor result).

Ratios do not have these limitations and that is why they are widely used to measure financial performance.

Let’s look at the first set of financial ratios: The Profitability Ratios.

Profitability ratios measure the business’ ability to generate profit as compared to its costs and expenses, over a period of time.

They are: The Gross Profit Ratio, the Operating Profit Ratio and the Profit Before Tax Ratio. Read more

Business Finance Consulting

Lean Finance – Continuous Improvement

After having in previous blogs highlighted the first two principles of Lean as they relate to the Finance function, Adding Value and Reducing Waste, let’s talk about the third and final principle of Lean: Continuous Improvement.

Broadly speaking, Lean projects need to commence with a Lean Analysis to assess the existing situation and determine the scope of the Lean Transformation project. From this, the Lean Transformation project can be further developed and implemented, focussing on opportunities to add value and reduce waste in order to optimise outcomes for the company (i.e. including the Fat Profits referred to in our book ‘Lean Business,Fat Profits’).

However Lean does not end when the Lean Transformation project is completed. Lean is a mindset, continually looking for incremental improvements.
Read more

Business Finance Consultants

Waste in the Finance Function? Surely Not!?

In a previous blog, we discussed applying the first principle of Lean (‘adding value’) to the Finance function. Today, let’s consider the second Lean principle: ‘Reducing waste’.

Yes, there can indeed be waste and missed opportunities in any Finance Department.

Here are a few common examples:

  • inefficient collection processes
  • the same data being manually entered several times in different systems
  • reports being generated for people that do not understand them and/or do not use them (in which case they are obviously not helping to guide the business)
  • complex report generation that requires the collection/analysis of data from multiple systems
  • cost allocation that does not add value to the decision making process, and
  • inappropriate budgeting processes that do not deliver outcomes aligned with the strategy of the business.

Read more

Business Finance Consulting

Can Finance be LEAN?

Most of our readers will be familiar with ‘Lean’ methodology and principles, which have been around for a number of years. But, like most people, some readers might primarily associate ‘Lean’ with manufacturing and everything that is linked with production.

In actual fact however, ‘Lean’ can be applied to every function in a business, including Sales, Marketing, Human Resources and Finance.

The Finance function is the same as all other functions in a company: It has processes (accounting, controlling, collection and reporting to name a few), which can be optimised through the application of Lean principles.

The three key Lean principles are Adding Value, Reducing Waste and the Continuous Improvement. Read more

Sand-money

Financial Assistance for Exporters

Are you an exporter or aspiring exporter? Is your turnover below $50 million?

If the answer is yes to both questions, you may be eligible to benefit from the Export Market Development Grants (EMDG).

The EMDG scheme is a key Australian Government financial assistance program for aspiring and current exporters. Administered by Austrade, the scheme supports a wide range of industry sectors and products, including inbound tourism and the export of intellectual property and know-how.

If you are currently benefiting from the EMDG, you already know of the 30th November 2016 deadline to lodge your application for the Financial Year ending 30th June 2016.

If you are not benefiting from the EMDG, keep reading… Read more

Sand-money

Money Has A Time Value

In these times of low inflation, it’s easy to forget or at least underestimate the impact of time on the value of money.

$1 today is worth $1. That is easy to understand. However, $1 last year was worth more than $1 today, and $1 next year will be worth less than $1 today.

One may believe that with inflation under 2% per annum, surely the impact of time on money is minor. But who knows of a business that has borrowed money at a 2% interest rate? Anyone? I certainly don’t. Most of the businesses I know are paying between 5 and 12%. And I am even not talking about the individuals or businesses that draw finance with a credit card and pay around 20%!

So money does have a time value and businesses need to take it into consideration when calculating future cash flows.

The general formula to calculate today’s value of a sum of money (or cash flow) that will be received in the future is:

Present value = Future value / (1 + Interest Rate) Time Read more

Business Finance Consulting

It’s Payback Time! …or is it?

Everyone facing a business investment decision, such as launching a new product, purchasing equipment, installing a new production line, building a factory or acquiring a business needs to ask themselves the following questions:

How long before I get my money back?
Which of these investments is better?

The Payback Analysis provides us with a means to answer these questions by clarifying the length of time (weeks, months or years) required for an investment to reach breakeven, before it begins returning a profit. This length of time is called the Payback Period.

The calculation takes into account Incomes, Expenses (*) and Taxes. The shorter the payback period, the better. The longer the payback period, the longer funds are locked up and the riskier the project.

Read more