Article Contributed by Irena McKenzie
Any manager or owner of a business will find themselves periodically in meetings with the company’s accountant. When taking time to review regular reports on the business’s finances, there are certain questions to ask and items to focus on to gain insight into the health of the business. These items will also help to identify early any potential problems, often before they ever arise. Here are a few questions to ask, along with reasons they are significant.
- Are there any unreconciled transactions? The process of reconciling transactions involves matching internally-accounted transactions with those reflected in company bank accounts, so naturally it is a red flag when there are transactions that cannot be matched. More likely than not, in a meeting with your accountant you will not need to ask about this point – they will bring it up almost immediately – but it is worth being aware if they have encountered any in your business recently. Having unreconciled transactions can mean that you have outstanding company checks, someone trying to overbill your company, or even potentially someone trying to steal from you.
- Are there any glaring control issues with company finances? Control issues can arise when one or more people within a company have sufficient control over the company’s finances (e.g. check-writing or wire transfer authority) that they can represent a risk to the firm. Accountants will often search for potential control issues during regular reviews, and it’s best to be aware of these potential risks as early as possible so you can determine the appropriate steps.
- What is the business’s free cash flow; is it higher or lower than in previous periods? Free cash flow is a measure of the business’s cash remaining from operations (income minus expenses) after any necessary investments in property or equipment. Essentially, this figure shows how much discretionary income that the business has left to reinvest, sustain itself through a fall in revenue, escalate investment in equipment, or undertake new marketing or other initiatives. In the world of personal finance, this measure would be like the amount you have left over each month after collecting income, paying your rent and mortgage, groceries, utilities, and car and student loan payments. This is how much you have left to save for a vacation, spend on meals or entertainment, buy a new personal computer, or pay for a class at a local college.
- What is the company’s current ratio? In finance, a current ratio is a measure of the company’s current assets (these include cash or those items that can be quickly converted to cash) versus immediate payables or short-term debts. An easy way to think of this number is to compare your business’s cash (or how much cash you could have if within 30 days if you converted certain liquid items to cash) to its debts due within the next 30 days. Ideally this number should be more than 3 to 5, meaning that your company has 3 to 5 times the amount of cash needed to pay off its short-term loans, but in almost no event should this figure ever fall below 1.5. The higher this number, the easier you should be able to rest at night; when it starts falling or nearing 2 or 1.5 is when you can start getting nervous and looking for ways to reduce debt or convert assets to more liquid cash.
- What is the average length of company receivables? This figure measures the average amount of time between when you send an invoice and when you get paid. You want to know if this figure is changing – especially if it is getting longer – because it could mean that you have one or more problem clients who may be a growing risk to your business.
- How concentrated are the company’s receivables? This question is in the same vein as #5, but it will help you to get a feel for whether your business has just a few clients who contribute most of your revenue. If one or a couple of these clients were to leave, there could be a substantial impact on your company finances. Diversifying clients, which can also be interpreted as spreading out your receivables, can help to reduce the risk presented by having just a few large clients on whom your business depends for survival.
It is worth noting that these are not hiring guidelines, or questions to ask of a potential accountant. These are aspects of a business’s financials that you need to know on a periodic basis. These are questions that need to be asked of whomever oversees the accounting for your business, whether it’s an accountant or mobile bookkeeper. Even if you are filling this role yourself, the items above are things that you need to track and periodically review. Hopefully they will aid you in identifying any potential risks to your business, and taking any corrective action as quickly as possible.
Irena McKenzie
Irena McKenzie is a Castle Hill local and is a very experienced local, mobile bookkeeper and successful small business owner. She has many years’ experience in all facets of bookkeeping and office work. She has run various small businesses for many years and understands exactly what it takes to get a small business up and running at full speed.