Determine the viability of your business

You hear the term 'viable business' more and more during the corona crisis. But what does that mean and how do you find out if your business can survive?

If the corona crisis hits you directly, then times can be difficult. Another lockdown could be the final blow for your company. You want to know what you can do to pull your company through the crisis. First, determine whether your business is healthy. In this article, you can read which factors determine the viability of your company.

What is a viable business?

A viable business is a business whose operations are profitable for a longer period of time and that can meet its financial and organisational obligations.

Gain insight

Insight into your business viability gives you, your suppliers, and your financiers an indication of the health of your company. If you know more about factors that determine health, you can make better decisions about next steps. For example, consider reducing your costs, adjusting your revenue model, seeking financing or, in the worst case, ending your business. A financier’s judgment on whether to provide financing depends on the factors that determine viability. If you have insight yourself and take the judgment of a financier into account, you will be a better sparring partner for that financier, and for other financial advisors such as a bookkeeper or accountant.

Map factors

You can determine viability based on financial and non-financial factors. You look at numbers about profitability, assets, liquidity, cash flow, and private income. With these numbers you can make ratios or calculation modules. You get these numbers from your profit and loss account and balance sheet, which together form the annual accounts. Non-financial factors concern the entrepreneur(s), the company, and environmental factors.

Cost-effectiveness

Cost-effectiveness is a way to measure the profitability of your company. You compare the profit with the average total invested capital (equity + loan capital). You calculate the average capital by adding the capital on January 1 to the capital on December 31 and dividing this by 2.

In a sole proprietorship, general partnership (vof), or public partnership, part of the profit goes towards an entrepreneur's allowance for the work delivered by the entrepreneur(s). For the calculation, the guide amount is €30,000.

Calculating cost-effectiveness

((net profit + interest paid - entrepreneur's allowance) / (average total invested capital) x 100% = cost-effectiveness.

  • Calculation example sole proprietorship:
    ((40,000 + 2500 - 30,000) / 50,000) x 100% = 25%
    In a private limited company (bv), the work of the entrepreneur(s) is already rewarded via salary or management fee.
  • Calculation of profitability at a bv:
    ((net profit + interest paid + tax on profit) / total assets) x 100% = cost-effectiveness
    Calculation example: ((50,000 + 25,000 + 45,000) / 500,000) x 100% = 24%
    A return on total assets of between 5 and 10% is acceptable to financiers. Higher numbers in the calculation examples mean that the companies have an above average profitability.

Table: Sample balance sheet

AssetsLiabilities

Fixed assets (1 year)

Equity

Real estate100,000Equity 55,000
Company assets  25,000





Current assets (< 1 year)
Long-term loan capital

Inventory  25,000Mortgage
80,000
Debtors  10,000Short-term loan capital
Cash  1,000Creditors10,000


Current account credit (overdraft)25,000




Total Assets170,000Total Liabilities170,000

Solvency

The relation between equity and total assets is called solvency. This is an indication of whether your company can meet its payment obligations in the long term. Financiers believe that a solvency percentage should be between 25 and 40. The standard for solvency differs per sector, per type of company, and per financier. Here you will find tips to improve your solvency (in Dutch).

Calculation of solvency

(equity / total assets) x 100% = solvency

Calculation example (with numbers from the sample balance sheet): (55,000 / 170,000) x 100% = 32%

Liquidity

Liquidity indicates whether you can pay your bills in the short term. You assess the liquidity of your company through your current ratio, quick ratio, and net working capital. The numbers in the calculations come from the sample balance sheet.

Current ratio

This ratio number indicates whether you can pay your (short-term) debts from your current assets. The value must be at least 1. For healthy companies it is between 1.2 and 1.5.

Calculating current ratio

current assets + liquid assets / short-term debt = current ratio

Specified: (inventory + debtors + cash) / (overdraft + creditors) = current ratio

Calculation example: (25,000 + 10,000 + 10,000) / (25,000 + 10,000) = 1.29

Quick ratio

This ratio number also indicates whether you can pay your (short-term) debts from your current assets. The difference from the current ratio, is that you do not include the value of the inventory in this calculation. A positive value for this prefix is at least 1.

Specified: (debtors + cash) / (overdraft + creditors) = quick ratio

Calculation example: (10,000 + 10,000) / (25,000 + 10,000) = 0.57

Net working capital

Net working capital is the difference between current assets and short-term loan capital on a company's balance sheet. Net working capital is positive if current assets are greater than short-term loan capital. With this money you can pay bills. It is money to use on a daily basis in your company and is therefore called working capital.

Calculating net working capital

current assets + cash - short-term debt = net working capital

Specified: (inventory + accounts receivable + cash) - (overdraft + accounts payable) = net working capital

Calculation example: (25,000 + 10,000 + 10,000) - (25,000 + 10,000) = 10,000

Cash flow

The cash flow (in Dutch) is the difference between receipts and expenses during a period. This is an indication of the cash-generating capacity of your company. Are your expenses greater than your receipts? Then your cash flow is negative. You will then need additional financing. Are revenues greater than expenses? Then you have a positive cash flow.

Calculation example: An entrepreneur receives € 30,000 in turnover in a quarter and spends €20,000 on purchasing and costs. The cashflow is € 30,000 - € 20,000 = € 10,000 and positive.

Private Income

Your business must generate sufficient income. As a guideline, banks maintain a minimum limit of €30,000. For a general partnership (vof) this is per partner. For a spouse firm it is €45,000 together. For a bv, a usual wage of at least €47,000 applies in 2020. A lower income may be sufficient for you. You then must convince a financier that you can meet your private obligations with that (temporary) lower income. Making a private budget (in Dutch) helps to prove this.

Entrepreneur and company

Your way of doing business influences the viability of your company. Therefore, take a critical look at the way in which your company is organised. Also look at it through the eyes of a financier. In addition to the figures, they also look at what kind of entrepreneur you are and what your company stands for. They want to hear your vision for the future and your strategy. They also want to know more about your experience, education, industry knowledge, network, and partnerships. The financier will want to know more about your company's legal form, the activities, the management information system, and the Key Performance Indicators (KPIs).

Environmental factors

Finally, environmental factors play a role in determining the viability of your company. These are developments that lie outside your company. They can present opportunities such as new technology, but also threats such as forced closure due to government measures. You have little influence on most of them, but you can take them into account.

Consider trends and developments that have an effect on your industry. For example, demographic factors such as age, growth, and size of the population. Or ecological factors in climate and energy. Socio-cultural factors include lifestyle and social trends. Technological factors are innovation and trends such as digitisation. With economic factors, you pay attention to the economic climate and purchasing power. Political-legal factors include legislation and the extent to which the government intervenes in the economy. Plan or show how your company responds to environmental factors.

Conclusion

If you go through all the factors, you can estimate the viability of your company. Do you score positively on the 5 financial factors? Then your viability looks good. There must also be sufficient prospects on the non-financial factors. Keep in mind that a financier usually looks more closely at these factors than an entrepreneur. And each financier uses their own numbers and percentages to weigh the value of each factor.

Do you expect to get a higher score in the future if you make some changes? Then continue doing business. Do you expect insufficient improvement? Then ending your business may be the right decision.

Help with financing

Help increases your chances of financing. With the right advisor and good financial arguments, a 'yes' to your financing application could be within reach. These advisors (in Dutch) will help you on your way.

Do you want to spar with someone about your financial situation? Call the KVK Financing Desk: 0800 10 14.

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