Choosing the right financial metrics for your business

Diving into your business’s core financial data may seem like a tedious activity that can often be confusing and time-consuming. But understanding where your business stands needn’t be too difficult if you’re looking at the right numbers to get the right results. Here’s where reports with the right metrics come to the rescue—they’re not mere sheets containing numbers; they’re statistical analyses that can show you the current outlook of your business.

Learning about your business’s financial metrics and picking the right KPIs can be simpler than you think.

Financial metrics: What they are and why they matter

Business metrics, or KPIs, essentially track and analyze numbers, and help you derive meaning from them. It’s a simple and effective way to understand your business position from a measurable value, in terms of achieving your goals within a certain period. For example, instead of looking through numbers to determine whether your business was profitable the previous year, you could streamline it with a profit and loss report that categorizes your income and expenses. When you know what is impacting your business, you’ll have better control of your business and its profitability.

Measuring your company’s performance is crucial; you can spot errors at an early stage and can rectify them before they affect your business further. For instance, you can spot a decline in sales numbers, and analyze and resolve the issue before it impacts profits. Moreover, you can make informed decisions about your business operations and investments (your information will be backed by numbers, and not just assumptions), track your company’s financial progress, and analyze its short-term and long-term outlook.

Ultimately, you can use financial metrics to identify strengths, weaknesses, and set targets for your business, so you can keep growing.

Choosing the right financial metrics for your business

While looking at a number of metrics, it may be easy to get confused. Not using financial metrics the right way can lead to a misstep in understanding where the business is headed, with additional time being spent on metrics that aren’t relevant to your business’s growth. To avoid this, it’s best to know which ones to look out for.

You should use business metrics based on your business goals, because they will show you how your business is really doing. Ideally, you should choose financial metrics based on your revenue, business target, cash flow, and your current business position.

• Metrics such as your sales revenue, net profit margin, gross margin, and other liquidity metrics address whether the company can meet short-term financial obligations.

• A few reports that will give you a clear glimpse of your financials would be your balance sheet, income statement, cash flow statement, and profit and loss reports (which are important for your company’s internal review, bank and tax reporting needs).

• Your accounts payable (AP) and accounts receivable (AR) aging reports will give you a clear idea of your dues and pending payments.

There are other metrics, ranging from those that will indicate growth (of revenues, markets, and profit shares) and losses. You should keep a tab on your business’s financial ratios to assess your efficiency ratio (cost of earning income), liquidity ratio (the extent to which your liquid assets can cover debts), and profitability ratios (how much you earn relative to sales).

Categorizing metrics

Categorizing metrics need not mean that they should strictly be meant for one particular purpose. You can assess metrics for multiple purposes (sometimes, metrics meant for profits can be used to understand your business overview, and vice versa), but when you measure metrics for a particular purpose (for instance, to understand why your cash flow is poor), you’ll be streamlining your efforts and encouraging growth in one particular aspect that was previously stagnant.

The following metrics have been categorized based on what you may want to focus on for your business. Go through them to identify what categories you need to focus on, and prioritize those metrics among the rest. This will help your business progress faster towards its goals. Some of the following metrics can be directly calculated, while the others can be viewed via reports present in your software.

Metrics for your company’s performance and business overview

1. Cash flow

As one of the most important metrics for any business, your cash flow metrics measure your company’s performance by evaluating the cash inflow and outflow, while also predicting your cash position in the future.

Your cash flow statement highlights the source of your money and shows how your cash flow is affected by your transactions. These will be categorized based on the kinds of transactions, such as investing, operating, and financing activities.

Cash flow metrics allow investors to understand your cash position, and help them decide if they should make an investment in your business. Measuring these metrics also lets you know how your business is faring with regard to income and expenses, while staying prepared for any unexpected changes that may come your way.

Quick calculation tip

Cash in hand = cash inflow (such as sales revenue and investments) – cash outflow (such as business expenses).

This cash in hand can be carried forward to the next month, to understand whether you have enough for your current expenses and future business plans.

Note: Understanding how to calculate your cash runway and cash burn will help you get an idea of how quickly you burn your money and how long you can operate your business.

2. Sales revenue

Regularly keeping tabs on your revenue lets you know how much you’ve earned from your sales. Most importantly, this metric acts as an indicator of cash flowing into your account as expected, and you’ll know if people are interested in buying your supplies.

When you analyze your revenue, you will get a good idea of whether your marketing goals are being achieved and whether anything has to be tweaked. You’ll also be able to understand the impact of your pricing strategy and can identify the supply that gives you the most revenue.

However, keep in mind that these numbers could be a result of several factors including recent changes in the market, seasonal preferences, and more. So, if the need arises to boost your marketing approach, you can do so, either by hiring more people or by introducing enticing offers for bulk or individual sales.

Quick calculation tip

Sales revenue = Income received from your sales – costs associated with the returned or undeliverable products.

3. Operating cash cycle

Your operating cash cycle measures the number of days existing in between the day you pay your suppliers and the day you receive income from your sales. Studying your operating cash cycle will show you the time it takes for cash to become available, so you can make an educated decision as to whether you can afford to make an investment.

Quick calculation tip

Cash operating cycle = (Inventory days + accounts receivable days) – payable days

Metrics to assess your growth and profit margins

1. Gross profit margins

Your gross profit margin indicates the percentage of revenue you have after removing the cost of goods sold (any costs involved in the direct cost of production, excluding operating expenses, interest, or taxes). It is, essentially, a measure of profitability, without accounting for overhead expenses.

When you establish your company and set a target towards a steadily growing business and revenue, you need to study your gross profit margins. As you do this, you’ll be able to analyze the profits you make, because the higher the gross margin, the higher the profit. On the other hand, a low gross margin would lead you to dig into the causes and amend them. Either way, you can get a head start on improving your business conditions.

Quick calculation tip

Gross profit margin = (Revenue – cost of goods sold) / Total revenue * 100

2. Net profit margins

This metric works similarly to the gross profit margin, except that it measures the percentage of your revenue after subtracting all costs (including operating expenses and interest). Looking into your net profit margins will give you an accurate understanding of the revenue you have in hand. When you analyze your financials through this metric, you will be able to know if your revenue has reached its target, and can make decisions accordingly.

With your net profit in mind, you will also be able to get an idea of the number of customers you’ll need to reach your targeted profit.

Quick calculation tip

To get the percentage of your net profit, you can calculate this:

(Revenue – all costs incurred)/Revenue * 100

Metrics to assess your spending patterns

1. Budget vs actuals (projected profit and loss)

This is similar to looking back on your cash flow projection, and measuring whether you have reached the target you had set out. Your budget vs actuals helps you manage your budget in each expense category. You may have planned a certain amount for a business trip, but your actual expenditure may be different. Going through this metric will help you analyze how often you cross the budget, and to what extent. This helps you understand how your business can stay cost-efficient.

Quick calculation tip

The difference between the budgeted amount and the actual amount will let you know if you’ve maintained the limit or crossed it.

2. Overhead costs

Paying expenses are a crucial part of the business. Overhead costs (also known as fixed costs) refer to the ongoing costs of running a business that you can expect, such as rent, legal fees, and more. These costs aren’t directly related to the creation or sale of your supplies, but are still important expenses to track as they show how much revenue you need to cover these costs, and how much you’re currently spending on such costs.

If the overhead expenses cross your budget, you can look towards reducing them by cutting out unnecessary expenses or by modifying your sales and marketing strategy to save more or earn more revenue to cover your overhead costs with ease.

Quick calculation tip

Add the business costs you’ve incurred (outside variable costs), and you will get the value of the overhead cost.

3. Variable costs

Unlike overhead expenses, these are expenses that are related to the creation or sale of your supplies, such as manufacturing expenses. When you track variable costs, you can manage the expenses of producing your supplies, and scale up production when required. That way, you get control and visibility over how you manage your expenses.

Quick calculation tip

Add the variable costs you’ve incurred (such as raw materials), and you will get the value.

You can even get the average by dividing the amount by the total number of units produced, if you want to get an idea of the amount for individual units. This gives you better visibility into how these costs change over time.

4. Working capital and current ratio

Working capital measures the difference between your current assets and current liabilities, helping you know how much you have in hand currently. Current assets are those assets that can be converted into cash within a year, while liabilities include those that have to be paid within a year.

Simply put, working capital is the amount of money that the business has in order to fund its daily expenses. A positive working capital is essential to meet short-term debts.

This metric depicts your company’s ability to pay its debts off. If the metric displays a value less than one, it means that the liabilities are more than the assets.

Quick calculation tip

Current ratio = current assets / current liabilities

Conclusion

By focusing on the right metrics, you can make educated decisions, and having the right software to help you out makes it easier. Zoho Books, a powerful accounting solution, simplifies your reports (aided with customization features, too!) and helps you assess the ups and downs of your business. Leverage your accounting software to make the best use of the tips mentioned above, and let your business grow at a steady pace.