SME’s in the UAE often find themselves living in “no man’s land” – too big to operate like a small business and too small to operate like a big business. This is especially true with regard to assessing the business financially in order to improve operational efficiency and save on costs. A very necessary emphasis on top line growth, along with a lack of the right tools and/or financial background, makes it very challenging for SME owners to sit down, gather data, analyze, plan and then execute. Moreover, a deeply-rooted personal investment in the business can lead to subjective biases that makes rational performance appraisal difficult. Sometimes you need a third-party, objective perspective. There are, however, solutions to these challenges.
One such solution is to understand exactly how a company is performing through the use of financial ratio analysis. Ratio analysis is not the end all, be all. It’s simply an objective, data-driven starting point for analyzing a business’ performance, understanding it strengths and weaknesses and where it needs to focus. And when used in conjunction with benchmarking the company against US or UK SME’s of similar size and in the same sector, ratio analysis can help a company understand whether they’re on the right track or not. Even more importantly, in a challenging business environment, it can help the company control costs and efficiently allocate resources.
By determining ratios with regard to . . .
Sales – Is the company’s expenditure on advertising, rent and payroll generating sufficient sales? Is the company overpaying in these areas?
Liquidity – Is the clock ticking on the company’s cash runway? Is the company managing Accounts Payable and Accounts Receivable to its advantage or are they beholden to clients and suppliers?
Profitability – Are the company’s profits margins, relative to peers, strong enough to attract investors or secure financing from lenders? What does the difference between gross and net profit margins say about the company’s operational efficiency?
Assets – Did capex investments in fixed assets actually improve sales?
Knowing and understanding financial ratios allows management to have a better understanding of a company’s strengths and weaknesses. How is the company performing today compared to years past? How is it trending going forward? What do these trends imply regarding cashflow? And when benchmarked against developed market peers, is the company moving in the right direction?
For instance, an analysis for one SME illustrated that the company was in the “green” on nearly all key financial metrics. The company had a lot of cash, AR days were good, but there was a red flag with inventory days. The client’s inventory days were 155 when the industry average was around 50.
After asking management about the unusually high inventory days, it was evident that the they didn’t even know they were carrying over 100 days of inventory. But with the proper analytical and forecasting tools, it was demonstrated that if the company better managed their inventory (i.e. lowered their inventory days), that would put $2 million dollars back in their account – a significant cost savings made possible by having better tools and understanding of how the business was performing.
Ratio analysis on another SME showed that their investment in a warehouse was more than worthwhile because it doubled their turnover to fixed assets - an important metric as they were seeking investments in order to open a new warehouse in another emirate. The improvement in the Gross Fixed Asset Turnover ratio clearly demonstrated the value add of opening a new facility.
As of the writing of this post, it is virtually self-evident that the business climate in the UAE is challenging. Is your SME financially healthy enough to make it through these times? Are you throwing good money after bad by investing in a business that has a low probability of success? Perhaps you’re doing well but are missing out on opportunities to do even better. We can help you address these issues by conducting ratio analysis, interpreting/explaining the results, showing you how your company compares to peers in the US and UK, and then making suggestions for improvement.
No doubt, some companies will not survive the current climate. But those who take their financial management seriously will improve their odds in this survival of the fittest, and position themselves to succeed after the downturn is over, when some of their competitors may no longer be in business. These are the SME’s that operate with big business management intelligence.