Five Essential Financial Metrics Every Business Owner Should Keep a Close Eye On

Business owners often get told that data is invaluable to their business. In the modern digital age where data on pretty much every aspect of business performance is readily available, we operate in a world of analytics, metrics, KPIs and targets.

Data from digitised systems might have made it possible to delve deeper than ever before into the health of our businesses. But keeping a close eye on financial performance is nothing new. At the end of the day, the ‘bottom line’ for any business is whether you’re turning a profit, and if so, how much.

All the essential financial data you need to keep track of how your business is doing is contained in your accounts. Making financial reporting an integral part of your analysis and oversight regime will go a long way to helping you plan for sustainable growth, and identify and address issues before they get too big.

Here are five essential financial metrics to look out for.

Profit Margin

As we say, this is the meat and drink of any business, and is surely a financial metric that every owner keeps a key eye on. There are, however, two ways to measure profit margin. You should understand the difference and what each has to tell you about business performance:

• Gross profit margin is calculated as a percentage of total revenue from sales minus the cost of goods sold (COGS).
• Net profit margin is calculated as a percentage of total income minus all operating expenses.

Net margin is, if you like, your ‘true’ margin, as it shows you how much profit you're making from your business activities when you take into account all costs. But gross margin is important to monitor as well because it zeroes in purely on the output from your purchasing, pricing and sales strategies. If your gross margins are low, it may be time to review how much you are paying for goods, or adjust your pricing, because it means your net margins are likely to be very thin indeed when other costs are taken into account.

Operating Expenses Ratio

Related to net profit margin, your operating expenses ratio measures the percentage of revenue that goes towards operating expenses, such as salaries, rent, utilities, and other overhead costs. In short, you want to keep this ratio as low as possible to protect your margins. If your operating expense ratio is high, it’s a sign that you could improve the cost efficiencies within your business.

Accounts Receivable Turnover

Good cash flow management is essential for every business. It’s the term used to describe the balance of incomings and outgoings. If you don’t get your cash flow right, you can find yourself in a situation where you have bills due but no cash in your accounts to pay them, because your own invoices haven’t been paid in time. That’s how a lot of businesses find themselves in insolvency trouble.

Accounts receivable turnover is an important metric for monitoring cash flow. It is calculated by dividing your total revenue by your average accounts receivable balance. This ratio tells you the average number of times receivables are converted into cash in any given accounting period. You should aim for a high figure, as this suggests you are converting receivables into cash regularly and efficiently.

Cash Conversion Cycle

Also known as the cash operating cycle, the cash conversion cycle measures how long it takes for investments and expenditures to be converted into cash from sales. Again, this is an important metric for monitoring cash flow. Spending money on stock, for example, takes money out of the business. Until that stock is sold, that money spent represents a hole in your cash flow. You therefore want to aim for as short a cash conversion cycle as possible, otherwise you could find yourself in that situation where there’s never any ready cash to pay your bills.

Budget and Projected Profits versus Actual

Finally, every business sets financial goals, including annual budgets and projections of profits and losses going forward. These are statutory requirements for financial reporting, but also play an important role in informing strategy and goals going forward.

Businesses set a course according to their budget and financial projections. But unless you keep a close eye on your actual expenditure and revenue as you go along, you won’t know if you are keeping on track. Operating according to financial projections when in fact the real-life situation is very different can lead to all sorts of problems.

 

Need help Monitoring your Business Finances?

Understanding and effectively managing your financial metrics is crucial for the success and sustainability of your business. These key indicators, from profit margins to cash flow management, provide valuable insights into your business's health and performance. To ensure that your business thrives, it's essential to stay on top of these metrics and make data-driven decisions.

If you're unsure about how to interpret or act upon this financial information, it's wise to seek professional guidance from an experienced accountant. Don't hesitate to reach out to us or find an accountant today to help you navigate these financial waters and set your business on the path to success. Your financial future is at stake, and we're here to assist you every step of the way.