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How to measure the financial health of an SME

formyjob by formyjob
March 31, 2021
in Banking, Investing
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How to measure the financial health of an SME
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At any time in the life of a small business, but much more so in times of crisis like today, owners must constantly measure the financial health of their companies. This is equivalent to having solvency, which is the ability to meet payments. Consequently, financial health will be better the more solvency the company has, which will also mean greater strength to face difficult situations such as that derived from the pandemic that is having a strong impact on SMEs.

The solvency ratios to access financing are based on healthy balance sheets and organized budgets

And for a small businessman, having solvency implies having sufficient cash and a healthy balance sheet, which, in turn, implies an acceptable level of debt.

This is how Gloria Batllori, professor in the Department of Economics, Finance and Accounting at ESADE describes it: “The theoretical economic models that are used for large companies cannot be applied as effectively to a small company, so it must adhere to simple principles which are to manage their debt level very well and have their own funds “. This specialist insists that the SME “has to be very rigorous with its debt, which consists of owing less than what is believed to be owed.”

Batllori exemplifies what an adequate level of debt is, dividing it into short-term and long-term debt. The first, so that it is at a healthy level from the financial point of view, “is the one that can be returned, that is, the one that is contracted with a supplier before selling the product but that, upon sale, disappears “. The second is more complex, according to the expert, and should be contracted only if the employer is very sure that his business will grow, so much so that, for example, it requires the construction of a new plant. “But, in this regard, the SME has to be very conservative,” she warns.

“Do not go into debt beyond what you can afford and, if possible, never beyond two months” is the advice of José Antonio Martín Herrera, first member of the Board of the Official College of Administrative Managers of Madrid. This professional affirms that the financial aspect of a company “has to be taken very seriously” and that debt is a factor of the first order. “Now, with the pandemic, we recommend not getting infected economically either, which means monitoring customers and rejecting possible businesses in which they are not convinced that there will be payment,” he says.

Again, the level of indebtedness is basic for another business expert, the general secretary of the Spanish Confederation of Small and Medium Enterprises (CEPYME), Luis Aribayos, for whom in times of uncertainty like the current ones “all expenses have to be restructured operational, reduce fixed costs and address debt with refinancing if necessary. “

Liquidity protection


Aribayos considers the treasury of an SME as the “fundamental” tool to check its financial health. “Preserving liquidity in the company’s cash register to function in one or two years from now is essential at all times and in the current situation with more reason, because we must not forget that many small companies are disappearing because they have not protected their treasury “, he says. In addition, there is another very important factor and that is that “when requesting financing or refinancing debts, financial entities analyze the situation of the treasury and the balance sheet to calculate the solvency ratio of the company”, emphasizes the general secretary of CEPYME.

Martín Herrera shares the same opinion regarding the importance of liquidity, of cash, in short. “You have to have funds and control them to face fixed expenses and those that arise”, he points out and adds that “in these months, with the almost general lack of income, the treasury has become an even more important element” .

The ESADE professor emphasizes that the company must have its own funds to ensure its solvency “and, above all, an emergency treasury fund.” In these times of pandemic, “you even have to have it higher than ever,” she adds.

A vitally important instrument for SMEs to measure their financial health is the company’s budget. Batllori explains that this serves to control liquidity and follow the evolution of the company. And in its preparation, tax planning is no less important, “because taxes are just another expense.” Martín Herrera advises doing it at the beginning of the fiscal year and “reviewing it periodically, taking into account the tax item”.

Both experts agree that a good budget is a very appropriate way to organize expenses by items, keep debits under control and set objectives. On the other hand, if you go to seek financing, the financial order provided by a well-organized computation is the best cover letter, they say.

THE RESTRUCTURING OF THE BUSINESS

The advice of specialists for an entrepreneur to determine how healthy his business is from a financial point of view is intensifying today. Luis Aribayos, general secretary of the Spanish Confederation of Small and Medium Enterprises (CEPYME), adds to the fact of having a solvent treasury and an acceptable level of debt, a restructuring of the business. “If the crisis lengthens, the business plan must be readapted, based on reducing costs or even suspending or selling non-productive lines. Financial entities will take this readaptation into account if they are asked for a loan,” he explains .

For his part, José Antonio Martín Herrera, first member of the Board of the Official College of Administrative Managers of Madrid, advises that, if the crisis leaves the company without liquidity, there are several options “to redirect the business, as is happening with many companies , or close to avoid prolonging a debt situation that can ruin the owners for life “.

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