How to Make a Business Financially Sustainable
Financially sustainable businesses are easier to adapt to changing market sentiment and better protected from bankruptcy. This statement is true for any company, be it a local flower shop or an international Live Casino Cookie. So, how to determine whether your business is sustainable and how to achieve the desired level of financial stability?
What Financial Sustainability Is
Financial sustainability is the ability of a company to adjust quickly to the changing market and continue to grow in profit and capital. There is no single criterion for determining financial stability, as there are several levels of financial stability.
Levels of Financial Sustainability: What Level Is Your Business at?
There are four levels of financial sustainability for a company:
- Absolute stability. There is enough money to cover expenses at its own expense. The business doesn’t depend on loans and other external sources of financing, which indicates high financial stability.
- Normal stability. The business’s expenses are covered by its own and borrowed funds. The amount of the company’s liquid assets is greater than the amount of its loans and credits. If necessary, the company can quickly get money and repay debts.
- Pre-crisis state. The company is starting to have financial problems. They can be solved by selling assets in the form of inventories, collecting receivables, and repaying debts with the proceeds.
- Crisis state. There isn’t enough money to cover all expenses and debts. This means that the business is rapidly moving towards bankruptcy.
Ratios for Analyzing Financial Sustainability
To determine financial sustainability with maximum accuracy, the calculation of ratios will help. They are calculated to see in figures how much the borrowed funds exceed their own. This will help understand how much it’s possible to allow a drop in revenue so that the business doesn’t slip into losses from this.
Operating Leverage
Operating leverage shows how much profit will increase or decrease when the business’s revenue changes.
Operating leverage serves as an indicator of business stability: the bigger it is, the less stable the business is. Under favorable circumstances, high operating leverage allows a business to grow faster and generate more profit. However, the higher the leverage, the more the business is dependent on revenue, and any difficulties will have serious consequences for the company.
Financial Strength Reserve
The financial margin of safety shows the limits to which revenue can be reduced so that it doesn’t go into negative territory. It’s measured as a percentage.
Of course, data for two months isn’t enough for a detailed analysis and identification of trends. You can get a complete picture by analyzing data for a longer period of time (six months or a year).
At the same time, the operating leverage indicator will help to adjust the company’s strategy only for the next few months, much less for a year. This is due to the fact that the market is changing rapidly, and the previously calculated operating leverage quickly loses its relevance. Other ratios will help to forecast the stability of the company for a longer time.
Financial Independence Ratio
It indicates the ratio of the company’s equity capital to the sum of all its assets.
It’s convenient to follow the dynamics of the financial independence ratio using the graph. It shows in which direction the indicator is changing now, where the company is now, in contrast to previous months, and when there was a similar situation.
If the autonomy ratio is low and the financial strength ratio is normal, the business is still heavily leveraged. You need to consider increasing equity and reducing the proportion of loans.
Equity to Borrowed Funds Ratio
It indicates how many times the organization’s debts are more or less than its equity.
Short-term liabilities are debts on loans and borrowings that need to be repaid within the next year, i.e. within 12 months.
Steps to Improve the Financial Strength of a Business
You can bring your company closer to the level of absolute financial strength by following a number of steps.
Start Planning for Cash Flow
There are two tools that help businesses do this: the Payment Calendar and the Cash Flow Budget (CFB). If you don’t already have them in your company, it’s better to start with the Payment Calendar and then the Cash Flow Budget.
The Payment Calendar includes all planned transactions for the month ahead: it helps to see the details of all future receipts and write-offs. Write-offs are loans, payments to suppliers, employees, and rent. Receipts are received by sales, customers, and debtors.
You can use the calendar to see how much money the business will have left, taking into account scheduled payments. This will help put things in order before the next big payment and avoid a cash gap. You can also plan operations in advance and compare the plan with the fact: whether we have paid everything and whether everything has been paid to us.
A cash flow budget allows you to manage the future cash flows of a business. With its help, you can find out how much money should come in and where it should go.
Unlike the Payment Calendar, a cash flow budget is created for a longer period of time, for example, a year in advance. This tool allows you to not only control but also strategically manage the movement of funds in the company.
Check Profitability When Revenue Falls or Rises
An increase in revenue doesn’t always guarantee an increase in profit. When turnover increases, the company’s expenses increase along with revenue. Because of this, profit may decrease. The profitability indicator will help you make a healthy assessment of the situation.
Profitability is an indicator that helps assess whether a business is operating efficiently. It reflects the ratio of profit to revenue and helps understand how a company’s profit changes as revenue grows.
To avoid problems, it’s necessary to analyze the reasons for a decrease or increase in revenue and profitability.
Control Borrowed Funds
Financial stability ratios help control borrowed funds. To calculate these ratios, data from the management balance sheet is used.
The three ratios to control are:
- Financial stability.
- Financial independence.
- The ratio of owned and borrowed funds.
If borrowed funds are not controlled, the company may become heavily leveraged. At some point, loans will become so large that they cannot be covered in time. Debts will appear, and the business will be stuck in a crisis state, which may eventually lead to bankruptcy.
However, an excess of borrowed capital over own capital is not always a bad sign. It all depends on the financial model of the business and the stage of its development.
Save for a Safety Cushion
A safety cushion in business is a special fund into which a portion of net profit is set aside. There can be several funds in a company, for example, a fund for development, dividends, employee bonuses, and the reserve fund.
From another point of view, funds are investments in the business for its stability and further development. For example, you can put part of the money in the bank and receive additional interest every week or month. Just don’t forget that the reserve fund should always be at hand so that money can be taken from it at any time.