Using tax time to do a business health check

The end of financial year shouldn’t just be about completing your annual return and keeping the tax man happy suggests Melanie Power, Xero's head of bookkeeping.

When utilised effectively, tax time can be a great opportunity to connect with your advisor and gauge the health of your business to review what is working well and what isn’t.   

Comparing income and expenses with previous years is a good place to start. However, businesses which use accounting software have access to a range of other data, which can provide deeper analysis and give business owners greater insights into how a business is performing.

Checking the value of your average invoice

When it comes to measuring the health of your business, a good place to start is by reviewing the volume of invoices being issued every month, and what each one’s average value is. It’s generally a positive sign of business growth if both are on the increase. If the number of invoices being issued is increasing but the average value shows little to no change, it could be an indication that you’re working harder for a lower return.

It could be time to re-evaluate how and which clients you service and most importantly, your pricing structure. It might be worth considering increasing your prices for the services and goods you are providing.

Measuring your cash flow

Cash flow is the lifeblood of any business. Average debtor days can tell you how frequently and how long it takes for you to get paid. Watch out for rising average debtor days as this is a sign that you may run into difficulties with cash flow.

It is possible to take immediate action to rectify high average debtor days. Instead of having to hit the phones, you can use a few automated tools instead. For example, an invoice reminder function will automatically remind your customers that payment is due without you having to lift a finger. Once that’s settled, it might be worth reviewing your payment terms and consider reducing the timeframe from, for example, 30 days to 14 days.  

However, chasing up old invoices and changing your payment terms is only the beginning. Ensuring you stay cash flow positive is critical to the long term success of any business, and even the most profitable business can come undone when it lacks cash to pay the bills.

Check your cash surplus for the month. How does the money received compare with your spending? Is your bank balance in a position to cover large, unexpected expenses? Arranging a line of credit as backup is worth considering to prevent any unforeseen situations.

A major trend in the service industry is to provide services at a fixed price with payment terms via automatic debit. The payment is usually made upfront before the service is provided. Changing your business model structure in this way can not only change the cash flow lifecycle but also have a major impact on the lifestyle of a business owner. Imagine being able to have a holiday at Christmas without having to worry about not getting paid for the time off! It can provide greater ease of mind and a more flexible work-life balance.

Costs of running your business

Evaluating business costs regularly as your company grows will help you get a good gauge of whether your expenditure is sustainable. In the early days of starting your business, costs will naturally be high as you invest in equipment, stock and in marketing. In an ideal business life cycle, however, costs should decrease and level out as your business matures.

Using automated accounting services allows expenses to be sorted into their appropriate categories. Expenses and direct costs can be separated and filtered, giving you visibility on your sales minus the cost of producing goods or the service you are selling, also known as your gross profit.

Start improving your business now

Business health checks can be performed at any time of the year and not necessarily in the lead up to June 30th.

It is good practice to spend 15 minutes a day familiarising yourself with each of the different metrics mentioned above. Getting a good understanding of each component will help you gain greater insight into your business, diagnose and address issues as early as possible.

Regularly doing health checks on your business will let you know what needs to improve and help you prevent problems before they happen.