Starting a business might be fun but running it successfully for many years is a tough ask! Entrepreneurs are like super heroes; they can achieve unprecedented success and can reach heights other cannot imagine. So, sometimes, it looks as if the company a person started might fail badly, but the determination and the hard work of its owner and team might change the situation. Ups and downs are also a part of life and it is quite hard to predict about the fate of a business given the situation at hand. However, using the financial knowledge, it is possible to visualize or rectify the performance of a business. This counts for small as well as giant businesses and business organizations.
If you have invested $ 1000 to start a business, when will your business be able to pay back those 1000 dollars? It might take 1 day, 1 year or even after 50 years! If a business is in loss then the owner should either quit it or rectify the problems. The key here is to match the amount you have spent or planning to spend to start your business as early as possible. The trends might be different for different businesses, but the most important part is your personal business skills and strategy. Planning these worst and best case scenarios can actually help you a lot. It can in fact save million bucks you might lose in future! All you need to do is just note the cash inflows and out flows of your business i.e. income and expenditure. When do you believe your business will break even? That might dictate the fate of that business and that is where weather to start or continue the business, or sell it!
If you earn $10 for an item, is it profit? Cant say. Well how much money did you spend in making that item? That again is a complicated question! You spent 1000$ to start the business, you cannot receive all those dollars by selling that single part. Anyways, the profit you earn after selling each item will tell you how the business will perform. The profit is simply, the amount you earn after selling that item minus the amount you spent on that item. Your setup, labor cost, marketing, every thing comes into that spent cost. The profit you earn after some period, say six months or a year will tell how much your business has grown or decayed. Also, your business might be earning some profit despite having negative cash! People are buying your products more than you anticipated, but after 2 years, still what your business has earned is less than what you have spent and then the net cash you have earned will be negative! But the business will be viable. A financial analysis might help you take the decision about your business.
The simple financial terms you should know for analysis are capital investment, cash, credit, interest rate, sales, profit margin and break even etc. First thing is that how will you arrange money to start the business? You might use your own savings or you might borrow money from a bank or a creditor. You also have to pay an interest rate on that money; depending on how does the business perform and how well do you manage to repay the debt. If your payment history is good and the business flourishes, then the interest rate you need to pay might be less. If the situation is opposite, you might well have to pay higher interest rates to minimize the loss to creditor.
Cash is the key for running your business. Even if the business hasn’t earned the amount that was spent on the setup, cash flow still will be required. Without cash, how will you buy fresh raw material or how will you pay the electricity bill? So, it is important for a business to earn sufficient amount of money for these bills and inventories. Then how will you pay your employees? Again sufficient cash is required. If not, then you have to borrow money. Then how many items are being sold per day? This will tell you about the future trends of your business and you will plan the inventories accordingly. This again is a very important performance indicator in terms of financial analysis. It will tell what improvements should be made to grow the business.
The profit margin is important too. It is a ratio of the total profit earned to the total amount of sales. This will affect your price setting and strategy for business growth. It is important for a business to earn profits, without that, the survival is endangered. When will the revenue earned by your business equal the money you spent is also important. After that, what ever you earn will be the profit your business earns. Keeping all these things in view, it is vital for a business to grow at a rate higher than the banks or any other investment offers. If your business earns a profit of 5% per year and an investment scheme offers 15% profit per year, then it is better to invest money there! Similarly, if the business is in loss and interest rates are mounting, it is better to sell that business and invest the money somewhere else!