If you’re seeing solid sales, gaining new customers, building positive relationships with vendors and more, you may think that your business is in great shape. However, there could be more lying beneath the surface that needs to be assessed than just “vanity metrics.”
In some cases, these metrics can be deceiving. To gain a clear perspective on your business’ health, you need to look for a few key signs.
A High Net Profit Margin
First things first. Look at your net profit margin to gauge your overall financial performance and the direction your business is heading. More specifically, compare it with other companies within your industry.
This graph from NYU displays margins by sector in the U.S. and will show you how your business stacks up against your industry at large. For instance, a company in the advertising sector with a profit margin of 10 percent would be showing signs of strong business health because the average net profit margin is only 6.04 percent. If that number was lower, at 3 percent, the business could be in trouble.
A Low Debt-to-Assets Ratio
According to Investopedia, “Total debt to total assets is a leverage ratio that defines the total amount of debt relative to assets.”
Why is this important? Knowing this ratio allows you to determine your company’s level of financial risk. In order to calculate your debt-to-asset ratio, combine your short-term and long-term debt and divide it by your total assets.
For example, a company with $1 million in short-term debt, $1 million in long-term debt and $5 million in total assets would calculate by dividing $2 million by $5 million for a debt-to-assets ratio of 0.4.
Generally speaking, the lower the number, the better your business health and vice versa. If you have a ratio lower than 1, you should be in pretty good shape. As Accounting Tools points out, “A ratio greater than 1 indicates that a company may be putting itself at risk of not being able to pay back its debts.”
Sustained Revenue Growth
You’re bound to see ups and downs in your sales figures. There are a plethora of different factors that can contribute to this including the season, product launches, promotions, industry trends, etc. But if you’re looking at your profit-and-loss statement and seeing a perpetual increase in revenue, then that’s a sign that your business is in good shape.
Keep in mind that this doesn’t necessarily have to be a massive surge in profitably. You’re just looking for a clear sign of upward movement over a prolonged period of time (e.g. three years or more).
Business health is critically important and is something you should consistently keep tabs on. If you notice signs of good health, that’s great. Rinse and repeat.
If you notice any red flags, it’s a sign that a particular area demands your attention. Carefully make the necessary adjustments before it’s too late and you’re in a crisis.