Financial reporting is absolutely critical to the success of small businesses. If you’re running your own enterprise, it’s important to have a clear picture of your financial standing at all times. Knowing the facts empowers you to remain objective when assessing your business’s financial health, and it also allows you to make informed, logical, and strategic decisions around your future growth.
So, how do you do this?
The answer is simple. With financial KPIs and metrics.
Key performance indicators (KPIs) are core business metrics that help to paint a clear image of how your enterprise is performing in specific areas. When KPIs are applied to finances, they can give you a clear picture of the overall financial health of your business. They’re also ideal for use in tracking your progress towards a variety of operational goals, whether these goals relate to money, marketing, supply chain management, or sales improvements.
In this article, we’ll explore the 5 key metrics you should use to assess, track and improve your small business’s financial standing.
Understanding Financial KPIs
Financial key performance indicators are measurements that compare a business’s performance to its specific financial objectives, like profits or revenues. They provide an overview of the financial health of an organisation against leading competitors, industry benchmarks, and other vital criteria.
These KPIs are commonly used during strategic planning and reporting processes to structure investment efforts and resource use. Moreover, tracking your KPIs and your business’s performance is critical to your success in the long term. You can use the data gathered to expand your operations, drive new revenue streams, and keep your profit margins consistent.
The 5 Core Metrics to Focus On
1. Cash Flow
Cash flow is one of the most powerful metrics for small businesses. Every small business owner relies on money to bring their vision to life and to sustain it in the future. But many leave cash flow out of the equation, damaging or even sinking their organisations in the process. Without sufficient cash flow, no business will survive for long.
There are many different metrics that fall under the cash flow umbrella. However, as a starting point, experts recommend focusing on monthly cash burn and runway (which refers to how long your business can operate) in particular.
2. Gross Profit Margins (GPM)
Are you looking to build a deeper understanding of your venture’s profitability? Your business’s gross profit margin indicates how much of its income is profit after considering costs such as the total cost of production. You can calculate GPM as a percentage using the following formula:
(Revenue – cost of goods sold)/revenue = GPM
Bear in mind that the cost of goods sold refers to all direct expenses that link to a product. Gross profit margins do not factor in tax, operational expenses, or interest. Your GPM should be high enough to take care of your business’s fixed expenses while still leaving you with a strong profit margin. A good profit margin benchmark is around 10% at least, but this depends on your industry. You can use these additional revenues for dividend payouts, marketing efforts, and other fluctuating expenses.
3. Net Profit Margins (NPM)
Your net profit margin determines how much of your revenues are profit as a percentage of your total income. However, while gross profit margin achieves the same goal, net profit margins take all of your expenses into account—not only your direct expenses. This means that taxes, interest, and operational costs get subtracted from the final figure. You can calculate your net profit margin using the following formula:
(Total revenues – total costs)/total revenues = NPM
Calculating your NPM allows you to project your future profit margins and create strategies to maintain your profitability. This figure will be lower than your gross profit margin, as it includes non-operational expenses. Improve your NPM by reducing non-essential expenses wherever possible.
4. Business Liquidity
Liquidity refers to the amount of cash a small business has on hand at present that can get used for immediate purchase assets and settle invoices. The current liquidity ratio is obtained by comparing a business’s current assets, such as inventory, receivables and cash, with all of its current liabilities.
You can also use a quick liquidity ratio to assess the health of your business. This ratio is calculated in the same way as the current ratio, but without considering inventory. If your enterprise’s quick ratio is lower than 1.0, this could indicate that your liabilities are exceeding the value of your assets and that your financial standing needs attention.
5. Return on Investment (ROI)
This financial KPI assesses the profits or returns your business is receiving on a specific investment or budget. ROI is expressed as a ratio of the money lost or gained on an investment of a defined amount. Return on investment can be calculated using this simple formula:
[(Gain – expenses)/expenses] x 100 = ROI
ROI is another essential indicator that tells you how profitable an investment is, and whether or not it’s worth your resources and time. A high return on investment on your marketing campaigns, for instance, suggests that they are profiting your business. While a low ROI could signal that you should be focusing your effort and money elsewhere. It’s important to note that optimal ROI ratios can vary widely between industries, sectors, and the investments in question.
Measuring The Future Made Simple
Each one of the KPIs listed above forms a critical part of a solid financial management strategy. Using them will help you to effectively track your organisation’s financial health and build goals and plans for long-term success.
Gaining a clear understanding of your cash flow and how to calculate profit margin is crucial to staying afloat. And, knowing how to calculate net profit margin, liquidity, and returns on investments will enable you to make informed decisions. Having a firm grasp on all of these facts and metrics will help you to maintain your business’s profitability, even during times of recession or economic churn.
One of the simplest ways to measure your small business’s financial health is to use a financial projection template that contains calculators for the KPIs mentioned in this article and others. Using a trusted template will provide a comprehensive framework for assessing your expenses, cash flow and revenues, helping you to create accurate projections and a highly efficient strategy for the future.
