6 Key Metrics to Understand Your Business’ Financial Position
As is the case in every aspect of business, the financial side of any enterprise contains a lot of moving parts and requires not only a great deal of understanding, but a significant portion of your attention as well. While the day-to-day workload can get in the way of analysing your business’ financial position, there are several crucial factors to measure when determining its financial health.
Think of your business as a series of moving parts of a machine. Should one of the parts begin to struggle and require repairs, other parts of the business need to work harder to compensate for it, thus putting pressure on those areas – similar to that of your car. It’s important to monitor the business and diagnose these potential problems before they become an issue (and eventually break down).
Here, we’ll take a look at six key metrics you can use to see if your business is heading in the right direction.
The Six Key Metrics
- Cashflow: You’ve probably heard the phrase “Cash is King” – it’s been around for a while and even today it is still one of the most reliable indicators of the financial health of any business. Monitoring the amount of cash going into your business against the amount going out advises whether you are operating in the red or in the black. The way to derive your cashflow is simple: Subtract your cash inflow (income generated from the sale of goods and/or services) from your cash outflow (e.g. bills, staff wages, tax obligations, license fees etc.). If your inflow exceeds you outflow, then your cashflow is in good shape. If the opposite is true, you should start developing strategies to improve your cash flow (this is where a solid business advisory relationship comes in).
- Gross Margin: Your business’ Gross Margin is an important amount / ratio to monitor as it shows how much money you have left over after you subtract the cost of goods sold or direct costs of delivering a service. It indicates whether the price you put on your goods or services is enough to cover your fixed business expenses and whether your pricing methodology is appropriate.
- Revenue: Revenue and Gross Margin have a close relationship, but the revenue itself is just as important to keep track of. It determines if you are earning the desired level of income or not, and helps you identify the elements that are contributing to your revenue increase or decrease – whether that be seasonality, changing consumer trends, the presence of competitors in your market, or a range of other factors. Your revenue / gross sales should be a key consideration when developing your overall business strategy.
- The Bottom Line: Referring to the net profit of your business is another key metric to measure its financial health. It shows the total income of the business after all expenses (including tax) are taken into consideration – a clear and simple way to determine your business’ overall position. Ideally, when planning for your business you should have a target to aim for to achieve your financial objectives and lead the lifestyle you are working towards. The net profit (inclusive of owner’s wages) is a great measurable of this.
- Profit & Loss Statement: Your P&L statement is a great tool to provide you with an overview of your financial position, as it calculates your business revenue and subtracts expenses. If the number on the P&L is positive, then your business is profitable at that moment in time. On the other hand, if the P&L displays a negative number, a loss has been incurred and it is high time you and your accountant look into how to turn that trend around.
- The Quick Ratio (The Acid Test Ratio): This ratio will be found on your balance sheet, and is an indicator of your business’ financial stability. The number is measured by dividing your current assets by your current liabilities – a ratio greater than 1 means that your business has more cash/assets available than is has debt owing.
Next Steps & How MP+ Can Help
The unfortunate reality of owning and running a business is that the exciting and satisfying parts of the job, the reasons why people get into business in the first place, are all too often overshadowed by the need to take care of the finances and keep close tabs on things like the key business metrics above.
Thankfully – McKinley Plowman are on hand to help. Not only will our CFO2GO and Accounting teams look after the numbers, our Business Development division pride themselves on helping you make those numbers stronger and more consistent as time goes on. When business owners’ partner with us, they have more time to do what they’re best at – running the day-to-day operations and reaping the rewards of a business run well.
If you’re ready to take the next step to understanding your business’ finance, and to see what we can do to help yours reach its potential. Contact us today via our website or on 08 9301 2200 (Joondalup) or 08 9361 3300 (Victoria Park).
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