Self Assessment: How Strong Is Your Business?

hsiybWhat is success? And how will you know if you are there? That’s more than a philosophical question–it’s one we entrepreneurial types grapple with regularly. Sometimes we struggle emotionally, as when we worry that the energy used building our businesses would have been better spent hunting for a real job. More often, our questions are practical: Am I making enough to justify hiring an assistant? Will my business qualify for a bank loan? Can I afford a new laptop? Am I on track here?

TAKING STOCK

Self-assessment is a crucial part of management, as well as startup market research tools, regardless of the size of the business. Unless you know how you’re doing, you really don’t know what to do next. Realistic financial self-appraisal makes for better decisions; it can also help you beat back the dragons of selfdoubt. A spreadsheet that says you’re doing OK is a potent weapon against the discouragement that can develop on a bad day. And a spreadsheet that’s disappointing can push you toward the renewed marketing efforts that might be just what your business needs.

“It helps to evaluate your business every quarter and to take a close look at the end of every year,” says Steve Cranfill, a principal in Management Advisory Services, a Seattle business consulting company. “It is a very, very useful and valid tool.”

According to Cranfill, there are three primary ways to take stock: You can measure yourself against your own goals, analyze the trends, and compare yourself to other businesses. It helps to do all three.

To do a good review of your business, start with a clean desk, a clean spreadsheet, and a clear head. If you stayed up all night worrying about your bills or arguing with your spouse about money, pick a different day.

Go easy on yourself if your business is new, notes Norman Boone, a San Francisco financial planner who has run through these assessments for himself as well as his clients. “You have’to judge with the life cycle in mind. The standards for someone in the first couple of years are going to be different than for someone who’s been doing things for several years.”

TRUTH OR CONSEQUENCES

With those reassuring thoughts in mind, here are nine tests you can put your business through to find out how you really, truly are doing.

1. The “You’re eating, aren’t you?” test.

You are covering your expenses, and then some. “If you are in your first year of business–or even the second or third– and you are paying the bills and keeping your head above water, you are doing pretty well,” notes Boone. After that, the test gets a little harder because you have to start adding in other expenses. By the time you’ve been in business for five years, your self-employment income should cover a comfortable lifestyle, including occasional vacation trips, nights out, disability, health, and life insurance, and a retirement savings plan.

2. The “real job” test. How much could you demand on the open job market? The best way to find out is to retain contacts and gossip. How much is the person who has your old job making? How much do the want ads offer for people with your skills? Several magazines publish annual surveys of salaries for employees in your chosen field. Add about 25 percent to that figure to cover fringe benefits. If you don’t stack up, don’t worry: For many of us, it’s worth a premium to work for ourselves in our own homes, and you’re probably saving money on career clothes and commuting. But if you find yourself putting in 16-hour days and seven-day weeks and not making what you could in a 9-to-5 job, it’s probably time to rethink the way you’ re working.

3. The return-on-investment test. If you were a publicly held company, would you be better off investing in yourself or in a bank account? This key financial calculation tells you how well your business is using your money, notes Cranfill. First, figure out how much money you spent to set yourself up in business, including the computer, phone bill, and business cards. Then, figure out how much profit you made in your first year by subtracting your salary from the amount of money left at the end of the year. If you are a sole proprietor and your profit is commingled with your salary, go back to the last test to figure out what portion of your earnings is a comparable salary and what part is profit.

Divide your profit by the money you spent to set up your business. Your return should be 12 percent to 15 percent of the money you’ve invested in yourself, says Cranfill, or you might as well just put your money in Treasury bonds and go find a job. (Or run your business leaner next year.) If, for example, you started your business with $6,000, you should have $720 to $900 left after taxes and salary in the first year to get into the 12-to 15-percent range. For the second year, just add new expenses to the bottom of the equation and new profits to the top.

4. The by-the-numbers test. There are rules of thumb for recognizing healthy businesses, Cranfill concedes, though he cautions that circumstances vary by business and situation. A “quick ratio,” for example, would divide your cash and receivables by your current liabilities, and “1 to 1 is acceptable,” he says. Another useful figure is the current ratio, which includes inventories among the assets that get compared to liabilities. There, “2 to 1 is a pretty well used guideline,” says Cranfill. What about debt-to-worth? That’s tricky, because debt does add risk, but a debt-free business might be one that isn’t growing enough. “The whole reason that debt is used is to help grow the business and increase the owners’ return on capital,” notes Cranfill. These days, a debt-to-worth relationship of 2 to 1 or below is considered good for a business.

5. The bend test. Keep a spreadsheet on a quarterly basis that figures all of these ratios, return on investment, salary, and profits. Set it up to compare like periods: third quarters to third quarters, full years to full years. Is your business moving in the right direction and fast enough? Growth-company investors like to see sales and earnings growing around 15 percent a year. Can you say the same for your business? At the very least, you should be moving up with the inflation rate (3 percent in recent years) and then some.

6. The I’ll-show-you-mine-if-you-show-me-yours test. Comparisons are among the most accurate measures of success, and many trade associations and professional groups allow us to compare our progress with that of our peers by taking surveys. Robert Morris Associates publishes reference books that give key ratios for many types of businesses, including small service businesses. You can make it part of your get-to-know-your-banker-better plan by asking her if you can look through the “RMA books.” Your banker will be impressed that you know what to look for; you’ll get a peek at how some of your competitors are performing. You can also make friends with people in your own field through national bulletin boards such as CompuServe and America Online. Discussions of rates and incomes are helpful–informal enough to stay this side of price-fixing conflicts, anonymous enough to skirt envy and client-poaching issues.

7. The profit centers test. Take some time to break down your business by clients, activities, and products. What activities and products make you the most money, and how much of your time do you spend on them? Which clients are the most profitable, and how much of your workload do they provide? You can look at this data and figure out if you’re focusing too much attention on small clients or on one large one, or whether you need to put more marketing energy into the one service you provide that really brings in cash.

8. The personal benchmark test. You probably are self-employed for a variety of reasons that aren’t all financial. Maybe you want to spend time with your family, maybe you enjoy the freedom of working in your pajamas, or maybe you hate commuting. Set your own goals and then see how your business matches up to them. Says Boone: “The issue is that you need to sit down ahead of time and say, ‘This is how I define success for myself.’ You might want to talk about income, liquidity, free time, and the quality of life. If you know what you are trying to accomplish ahead of time, it becomes easier to set up plans, and if you don’t know where you are going, you probably won’t succeed.”

9. The all-important gut check. If you don’t have time for all the number-crunching and self-contemplation, take a moment to ask yourself how it all feels. “If your business is growing, if you are seeing new clients and customers so that your business is moving in the right direction, and if you feel comfortable, then you are a success,” says Boone. In the final analysis, you have to feel good in your own skin. Or, if I may be permitted one more quote before I put down my books and get to work, as American writer (and Bartlett’s Quotations editor) Christopher Morley once said, “There is only one success–to be able to spend your life in your own way.”

Tags: ,

One Response to “Self Assessment: How Strong Is Your Business?”

  1. Hank Phelps Says:

    I am thinking of setting up my own business some time soon and thanks I learned a lot from this article. Of course, the business I have in mind isn’t a big one. But the pointers above can still help! Although my job is stable, it’s still a must to have other sources of income nowadays.

    It won’t be long now… road to riches, I tells ya 😉

Leave a Reply