Directors' Advice Guides
Taking advice, or asking for advice, can often be the hardest steps of all in this process. It symbolises the realisation and admission that you do indeed need some help. To provide you with information which may reassure you, or point you in the right direction, we've created, and continue to create, key guides which you can use as a key resource during this stage of your decision process.
A guide to....spotting the signs of crisis
The sooner you seek the appropriate advice, the sooner you can start working towards a debt free future.
Spotting the signs of financial crisis can be easily done by reviewing your financial information.
Let's take a look at a few accounting ratios which can help you identify a number of key performance indicators.
There is a Gross Profit ratio which identifies the percentage profit from sales required in order to pay overheads.
The gross profit ratio is calculated as follows:-
The gross profit divided by total turnover times 100.
If you have management or historic accounts run this ratio over a number of months or years. Any reduction could be the failure or inability to pass on any cost increases to your customers, stock losses, identifying a fraud, an attempt to increase market share by keeping prices down thus maintaining low margins.
There is a Gross Profit Mark Up ratio which will help identify the percentage profit added to the cost of goods sold.
The Gross Profit Mark Up is calculated as follows:-
The gross profit divided by cost of sales times 100.
There is a Net Profit ratio which will help identify the operational efficiency of the business without reference to how the company is financed.
The Net Profit ratio is calculated as follows:-
The net profit before interest and tax (or EBITDA) divided by turnover times 100.
Current assets test is calculated as follows:-
The current assets divided by current liabilities.
As a general rule the result should be between 1.5 and 2.
If the result is too low, the business may face difficulties in repaying debts and if greater than 2 then there is a suggestion that cash is tied up unprofitably in excess current assets as either cash lying idle in the bank or excessive stock levels. If a high proportion of the current assets are stock then in order to meet current liabilities you may have to sell stock quickly which could lead to discounting for a quick sale.
Acid test is calculated as follows:-
The current assets less stock divided by the current liabilities.
As a general rule the result should be 1. If this is 1 then it is an indication that the company should have sufficient funds to pay the current liabilities. If this is lower than 1 then it may be an indication that there are cashflow difficulties.
There are a number of efficiency tests that you can undertake to establish whether you are turning over stock at the required rate, collecting your debts in a timely manner, paying creditors on time.
The calculation for Stock Turnover is as follows:-
The stock divided by cost of sales times 365.
This will identify the time it takes for the stock to turnover.
The calculation for Trade Debtor Collection is as follows:-
The average trade debtors divided by total credit sales times 365.
This shows the average time it takes to collect the debtors.
If there is difference between this figure and trade creditor payment period (below) this could identify areas of weakness and holes in the cashflow. If you run this calculation over historical management information and the time period is increasing this is an indication that there are a number of bad debts or alternatively that debt collection is an issue that needs addressing.
The calculation for Trade Creditor Payment Period is as follows:-
The average trade creditors divided by total credit purchases times 365.
This will identify the average number of days to pay your debts. If you run this calculation over historical management information and the time period is increasing this is an indication that you are finding it difficult to pay debts as and when they fall due.