Bankers can help small businesses by asking them questions about their businesses that will help the business owner better understand his financials. In addition, the discussion that follows these questions can uncover banking products that could help the business grow profitably.
Here are five questions to ask:
1. What is the business productivity ratio?
The business productivity ratio answers the question, “For every dollar that comes in the door how much are you spending on payroll and payroll taxes?” The ratio should be fairly consistent from month to month for most businesses. Product oriented businesses should have lower productivity ratios than service oriented businesses. For businesses that are seasonal, then the ratio will fluctuate depending on the season. Watch out for ratios higher than 1. This means that for every dollar the business generates in revenues it costs more than a dollar just to cover payroll!
2. What is your business net profit per hour?
The business net profit per hour answers the question, “For every revenue producing hour, how much is the business bringing to the bottom line?” Net profit per hour is calculated as total net profit divided by revenue producing hours. Do not include holiday, vacation, training hours, or any hours that are not used to produce products and services. If the net profit per hour is negative, then the business is paying the customer to produce its products and services. If the net profit per hour is under $10 per hour, then the business owner could work for someone and probably earn much more without the headaches and stress of running a business. Once a business owner sees his net profit per hour, he usually wants to increase it because he doesn’t like a low number.
3. What is your business overhead cost per hour?
The business overhead cost per hour answers the question, “For every revenue producing hour, what overhead expense do I need to add? Overhead cost per hour is calculated as total overhead cost divided by revenue producing hours. This includes all overhead for a company, or for larger companies, for a department. If the overhead cost per hour is $30 per hour, then $30 must be added to each revenue producing hour to establish the break even price for a product or service.
4. How long does it take from the time you send an invoice to the time you get paid?
This is a company’s receivable days. It is calculated using annual sales divided by accounts receivable to get receivable turns. Then 365 divided by receivable turns is receivable days. It is important to have actual receivables. If there are some “doubtful accounts” these should not be included in this calculation. As part of the discussion, all business owners need to understand that sales are not revenues. They could sell $1,000,000 worth of product and not get paid for it for 90 days. The receivable days in this case is 90 days. Once a business owner understands receivable days and that sales are not revenues, a banker can usually start a conversation about the potential need of a line of credit or other banking instrument.
5. What is your current ratio?
This is a question that most bankers are familiar with because current ratio is usually specified in loan covenants and is critical to the health of a business. Make sure the business owner uses only actual current assets and actual current liabilities. They should not include accounts receivables that are due to owners that won’t be paid within a year. They should include a current portion of long term debt in this calculation too.
Asking business owners these five questions will help bankers help their business customers and promote great discussions about potential banking products that could be used by those businesses.
Ruth King is CEO of Profitability Revolution Paradigm and the #1 best-selling author of “The Courage to be Profitable: Get and Stay Profitable in Less than 30 Minutes a Month.” Reach her at firstname.lastname@example.org.