Understanding your business’ financial metrics, and what those numbers are telling you, is critical to running a successful business. These metrics are crucial to knowing whether or not your business is profitable, and will also prevent you from waking up one day to find out you’re on the slow march to insolvency and going out of business. There are a handful of metrics every business owner should be familiar with.
Five Important Small Business Financial Metrics You Need to Understand
Most of these metrics are pretty straightforward and logical, and this short guide will help you to shed some light on how to monitor these metrics within your business. Familiarise yourself with these five metrics, as they are some of the more crucial numbers to know to run a successful business.
Income: Without business income, or revenue, nothing else happens. Nobody gets paid. Products don’t get delivered. Supplies can’t be purchased. Without revenue, businesses can’t sustain operations. Thus, income is one of the first metrics you need to be intimate with. Track this number daily, weekly, monthly, quarterly and annually, so that you can compare how you are doing today with how your business was doing last year, month, week, etc.
This is an important number to a lender, as well. One of the things they are trying to evaluate when they review your loan application is whether or not you have the income to make any periodic payments associated with a potential small business loan. Without revenue, your business’ ability to service debt will be considered questionable.
Fortunately, this is a fairly easy number to capture. What are your total sales?
Expenses: There are several ways to categorise your expenses, and your accountant can help you with those, but ultimately, you want to know what it costs to do business and whether or not your business income is sufficient to meet those business expenses. It’s the difference between your income and expenses that determines if your business is profitable or not. After all, profits should be one of the primary goals of going into business for yourself.
Granted, there are some businesses today (particularly in the tech space) that forego profits in the beginning and focus more on growth. To do this, they rely on investor income, rather than profits, to fuel the fire of growth before they become profitable. That’s how companies like Facebook, Twitter and Uber became household names. These investors forecasted that their returns would be exponentially greater by investing today for a potential payout down the road. If your small business has the potential to grow and scale profits with the infusion of capital, you are probably considering this, but most small business owners need to focus on selling their goods or services for more than it costs to produce them, so they can generate profits.
Cash Flow: Inadequate cash flow has rung the death knell for many small businesses over the years. If you’ve ever heard the term ‘Cash flow is king’, this is what it’s talking about. It’s not enough to simply have money in your business checking account at the end of the month; you need to understand your Cash Flow Metric.
You calculate this metric by dividing your assets and your liabilities. This is an essential metric, so if you’re unsure about how to define assets and liabilities, speak with your accountant to make sure you’re clear on the definitions. The ideal goal for this metric is 2:1, or twice as many assets as liabilities. Understandably, this 2:1 goal is challenging for many businesses to maintain, but anything below 1:1 should be a big red flag that your business doesn’t have adequate cash flow to maintain operations.
This metric is also an important consideration when looking at a potential small business loan. Loan payments become liabilities, and if those payments pull your metric down below 1:1, it could indicate that you are borrowing your way into trouble. Having a handle on your cash flow metric is critical to small business success.
Accounts Receivable (Debtors) Aging: This is an important metric that you can’t afford to ignore. How long does it take your customers, to whom you offer credit terms, to pay their invoices? If you offer 30-day terms, do they consistently pay within those 30 days or do they sometimes pay late and go beyond 45 or 60 days?
Accounts Payable (Creditors) Aging: Another number you should know is the average number of days it takes you to meet your business’ financial obligations. If you’re able to effectively manage your debtors, your cash flow and your income, you should be able to keep your creditors current and maybe even take advantage of the prompt payment terms your suppliers will likely offer you.
As a business looking for borrowed capital, the single most important thing you can do to positively impact your business credit rating and increase the options you’ll have when it comes time to borrow, is to stay current with your business credit obligations. That includes your utility bills, your business lease, your credit relationships with vendors and any other business credit obligations you may have.
There are many more business financial metrics that you can measure to keep an eye on your small business, but these five metrics outlined above are crucial to getting started on reviewing the state of your business. Commit to keeping track of these numbers each day, week, month and year and you will be well on your way to running a successful business.