Profitability is the ability to earn a profit. Many start-ups are not profitable their first several months of operations, as discussed in Truth 47, “Financial objectives of a business,” but they must become profitable to create a sustainable business and provide a return to their owners.

A business also must know if its profits are increasing or declining and whether they are leading or lagging industry averages. The first question, whether a business’s profits are increasing or declining, can be answered through the maintenance of accurate financial records. The second question, whether a business’s profits are leading or lagging industry averages, is tougher. Normally, businesses collect this information through informal conversations with industry peers or by joining an industry trade group, which typically collects information about the average profitability for businesses in the industry.

Obviously, if a business’s profits are declining (or are nonexistent) or if the business is lagging industry averages, corrective action is necessary. One thing that continually surprises small business counselors is the number of small business people who don’t have a good grasp on whether their profits are increasing or declining and how they stack up against their industry peers. Don’t fall into that group. Stay on top of these issues so you can take corrective action immediately if necessary.

Liquidity is a company’s ability to meet its short-term financial obligations. As indicated in Truth 46, “Managing a business’s finances,” a business must carefully manage its cash to make sure it has enough money in the bank to meet its payroll and cover its short-term obligations.

Normally, the biggest culprits in straining a business’s liquidity are letting its accounts receivables or its inventory levels get too high. There are many colorful anecdotes about business owners who have had to rush to a bank and get a second mortgage on their houses to cover their business’s payroll. This set of events usually occurs when a business takes on too much work and its customers are slow to pay. A business can literally have a million dollars in accounts receivable but not be able to meet a $25,000 payroll. This is why almost any book you pick up about growing a business stresses the importance of properly managing your cash flow.

Some businesses deal with potential cash flow shortfalls by establishing a line of credit at a bank or by maintaining a healthy cash reserve. Other businesses are careful not to take on too much work, so their accounts receivable and inventory levels remain manageable.

Stability is the strength and vigor of the business’s overall financial posture. For a business to be stable, it must not only earn a profit and remain liquid but also keep its debt in check. If a firm continues to borrow from its lenders and its debt-to-asset ratio (which is calculated by dividing its total debt by its total assets) gets too high, it may have trouble meeting its obligations and securing the level of financing needed to fuel its growth.

Many business owners are caught off guard by the continuing need to remain vigilant regarding the overall financial stability of their business. You would think that if a business got off to a good start, increased its sales, and started making money, things would get progressively more stable. In many instances, however, just the opposite happens. Imagine the following scenario. A business gets off to a fast start and projects that its sales will double in the next two to three years. To make this happen, the business needs more people and additional equipment to handle the increased workload. The new equipment needs to be purchased, and the new people need to be hired and trained before the increased business generates additional income. Even though the business might be better off in the long run as a result of the increased business, it’s easy to see the strain that’s placed on the business in the short run to get there.

Many business owners are caught off guard by the continuing need to remain vigilant regarding the overall financial stability of their business.