Business Financial Metrics – # 2

Posted: February 4, 2013 in Business Financial Statements, Up-and-running Business
Tags: ,

This is not a new metric. It is the business capitalization ratio. It is the ratio of short term and long term liabilities (less shareholder loans) divided by shareholder equity plus shareholder loans. I call this the small business beta.

Beta =  Current + Long term liabilities / Shareholder equity + Shareholder loans

Short and long term debt is provided by outsiders. This is outside capital. Shareholder loans and shareholder equity (including annual profits) is provided by insiders. The outsider/insider ratio shouldn’t be any greater than 1.3:1. A low beta means less risk of all types. A high beta is indicative of higher risks and a short term business focus. Businesses with high betas struggle to meet payroll and pay key creditors within their credit terms.

Small business beta is a combination of many risks:

  • Business risk
  • (local) market risk
  • Interest rate risk.
  • Financial risk
  • Plus other risks

You find outside and inside capital on the “liability and shareholder equity” side of the balance sheet. Your bank certainly looks at how well you manage your capital and they do this by comparing outside funds with funds generated internally (most notably by profits) on a year-over-year basis.

So understand how your business is capitalized. The higher the beta the more risk for your business and probably the higher your blood pressure and overall stress level.

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