As a business owner, it's crucial to understand the financial health of your company. One way to do this is by tracking key financial metrics to measure your business's performance. These metrics can help you make informed decisions and take necessary actions to improve your company's financial position. In this blog post, we'll discuss the top financial metrics every business owner should know, back them up with statistics and use cases, and provide actionable tips to help you improve your business's financial performance.
1. Gross Profit Margin
Gross profit margin is the percentage of revenue that remains after deducting the cost of goods sold (COGS). It's a key indicator of a company's profitability and efficiency in managing its production costs. A higher gross profit margin indicates better profitability and efficiency.
For example, a company that sells goods for $100 with a COGS of $60 has a gross profit margin of 40% ($40/$100). A higher gross profit margin means that the company has more money to cover other expenses such as salaries, rent, marketing, and other overheads.
According to a survey by Sageworks, the average gross profit margin for small businesses is around 27.7%. However, this varies depending on the industry. For example, retail businesses typically have lower gross profit margins due to the high cost of inventory, while service-based businesses have higher gross profit margins.
To improve your gross profit margin, you can focus on reducing your production costs by negotiating better deals with suppliers or finding ways to optimize your manufacturing processes. You can also increase your pricing strategy to ensure that your revenue covers your COGS and leaves you with higher profits.
2. Net Profit Margin
Net profit margin is the percentage of revenue that remains after all expenses have been deducted, including taxes, interest, and depreciation. It's a more comprehensive measure of a company's profitability than gross profit margin because it takes into account all expenses, not just production costs.
For example, a company that generates $100,000 in revenue but has $80,000 in expenses, including taxes, interest, and depreciation, has a net profit margin of 20% ($20,000/$100,000). A higher net profit margin indicates better profitability and efficiency in managing all expenses.
According to a report by QuickBooks, the average net profit margin for small businesses is around 6%. However, this also varies depending on the industry and the size of the business.
To improve your net profit margin, you can focus on reducing your expenses by finding ways to cut unnecessary costs or negotiating better deals with suppliers. You can also look for opportunities to increase your revenue, such as expanding your customer base, introducing new products or services, or improving your marketing strategy.
3. Accounts Receivable Turnover
Accounts receivable turnover measures the rate at which a company collects payments from its customers. It's calculated by dividing the total credit sales by the average accounts receivable balance. A higher accounts receivable turnover indicates that a company is collecting payments from its customers more quickly and efficiently.
For example, a company that has $500,000 in credit sales and an average accounts receivable balance of $50,000 has an accounts receivable turnover of 10 ($500,000/$50,000). This means that the company collects payments from its customers ten times in a year.
According to a survey by Fundbox, the average accounts receivable turnover for small businesses is around 48 days. However, this also varies depending on the industry and the size of the business.
To improve your accounts receivable turnover, you can focus on improving your billing and payment processes, such as sending invoices promptly, offering multiple payment options, and following up with customers who are late in making payments. You can also consider implementing an automated system to manage your accounts receivable to ensure that payments are collected on time.
4. Cash Flow
Cash flow measures the amount of cash coming in and going out of a business over a specific period. It's a crucial metric to track because it affects a company's ability to pay its bills, invest in new opportunities, and grow. A positive cash flow means that a company has more cash coming in than going out, while a negative cash flow means that a company has more cash going out than coming in.
According to a survey by JPMorgan Chase, 82% of small businesses experience cash flow issues, with 29% citing it as their biggest challenge. Poor cash flow management can lead to missed opportunities, late payments to suppliers or employees, and even bankruptcy.
To improve your cash flow, you can focus on reducing your expenses, increasing your revenue, and managing your accounts receivable and accounts payable effectively. You can also consider implementing a cash flow forecast to help you anticipate future cash flow issues and take proactive steps to address them.
5. Return on Investment (ROI)
ROI measures the return on an investment relative to its cost. It's a critical metric for evaluating the profitability of investments and making informed decisions about future investments.
For example, if a company invests $10,000 in a marketing campaign that generates $20,000 in revenue, the ROI is 100% (($20,000-$10,000)/$10,000). A higher ROI indicates that an investment is more profitable.
According to a study by Deloitte, companies that use ROI as a performance metric are more likely to have higher revenue growth rates than those that don't. ROI can also help businesses prioritize investments and allocate resources more effectively.
To improve your ROI, you can focus on identifying and investing in opportunities that have higher potential returns. You can also track and analyze your ROI for different investments to identify areas for improvement.
Conclusion
Tracking these financial metrics can help you understand the financial health of your business and make informed decisions to improve its performance. By focusing on improving your gross profit margin, net profit margin, accounts receivable turnover, cash flow, and ROI, you can ensure that your business is on the right track to success.
Remember that these metrics are just a starting point, and there may be other metrics that are more relevant to your specific industry or business. It's essential to work with a trusted accountant or financial advisor to identify the metrics that matter most to your business and develop a plan to improve them.
Finally, if you're struggling to manage your finances or need help improving your financial metrics, consider reaching out to KPI Business Advisory. Our team of experienced professionals can provide you with the support and advice you need to succeed. Contact us today to learn more about our services and how we can help your business thrive.