All too often, you are met with multiple sources of financial information from your client – how do you sort through it all and come up with an analysis of their business in a timely manner? As the financial advisor, you need to be the source of guidance to your clients. Showing your client how their business is really doing and how to maximize cash will build your relationship with them and create loyal clients.
But how do you do it? How can you do this for all your clients?
Easy. 6 simple calculations and ideas will show you the true financial health of your client’s business. And here they are:
- Trends
- Expense Control
- Debt to Equity Ratio
- EBITDA/Long-Term Debt Availability
- Mis-Financed Assets
- Cash Flow Activity Pattern
For a deeper dive into this topic, make sure to join our webinar on March 9 at 4 p.m. Eastern Time, "How to Eat an Elephant in 6 Simple Calculations: Assessing Your Client's Financial Health." You can register for this webinar here.
Trends
Trends are analyzed using the Income Statement and look at four different categories: sales, gross profit, operating expense, and net profit. What is the correlation between Year 1 and Year 5 in all of these categories? Each category could be classified as increasing or decreasing – and once you classify each category, you can look at them as a whole. There are only eight different combinations here and they all mean something different.
Use this trend analysis as the first overview of the business.
Expense Control
There is one rule to owning a business and you need to make sure your client knows it:
The change in your operating expense dollars should mirror the change in your gross profit dollars.
Only spend the money you have – if you have less dollars, spend less dollars. Sounds easy right?
Operating expense is a little different because it takes a management decision to change. So, as you are looking at your client’s numbers, if you see their sales and gross profit declining but their operating expense is still climbing, your advice should be to control their expenses. They need to make a decision that keeps their net profit margin in the green. Don’t let them get to the breakeven point – if you start implementing expense control now, you can keep a profitable business.
Debt to Equity
Debt to equity ratio compares the amount of money you borrowed with the amount of money you invested in it yourself. It shows how much you believe in your company. This ratio is calculated y dividing Total Liabilities by Total Equity. A good number here is 2.5. This means for every $1 your client invested in their company, they let the bank invest an additional $2.50. Lower than 3 is good and shows less risk to the bank. The best way to give advice here is to ask your client if they will be looking for a loan in the next year. If the answer is yes, they need to start investing in themselves now so they can have a good standing in the future. If not, take the stance as an accountant and help your client pay as little tax as possible.
EBITDA
As a banker or accountant, you are probably very familiar with this calculation, but your clients aren’t. I bet you could count on one hand how many times your clients have asked you for this number.
EBITDA is Earning (net profit) Before Interest, Taxes, Depreciation, and Amortization – but really just a proxy word for Cash Flow. This number shows you the overall financial performance. EBITDA is usually a better number than your reported earnings and shows the ability to take on new debt.
As a rule, you as the accountant, can use this number to determine what the Long-Term Debt Capacity for your client is. Your client’s L.T.D. Capacity is usually 3 times EBITDA and calculating this for your clients can be helpful to them when talking about future growth.
Mis-Matched Financing
You wouldn’t buy a house with a credit card…so don’t let your clients buy things for their business with the wrong loan product! If you’re doing it right, the loan’s length should match the life of the asset. So, if I can depreciate an asset for five years, I should use a five-year term loan to finance that asset’s purchase. That way, when the depreciation schedule ends, so do your payments for the asset.
This isn’t something that happens on purpose, but it is something crucial to look for. If not fixed, this could kill a business. Here is where you need to look: gross fixed assets, long-term debt, and retained earnings. To diagnose mis-financing, you will need to look at the variations in these three categories over a multi-year period.
Cash Flow Activity Pattern
It is important to also talk about the Cash Flow Statement. The main categories in a Cash Flow statement are operating activities, investing activities, and financing activities. Cash Flow from these three activities can either be negative or positive.
All of these things are important when trying to get a quick understanding of your client’s business. Start your consultations with this 7-minute conversation and really grasp the financial health of their business.
For a deeper dive into this topic, make sure to join our webinar on March 9 at 4 p.m. Eastern Time, "How to Eat an Elephant in 6 Simple Calculations: Assessing Your Client's Financial Health." You can register for this webinar here.