It’s important to determine where you stand when running a business. You might get so caught up in the day-to-day duties that you don’t step back regularly and look at the big picture. Here are 12 key areas to look at when assessing how your business is doing financially. Staying on top of these benchmarks can help you plan for the future and avoid financial problems.
If you’re seeking funding from lenders, investors, or other potential financiers, chances are you’ll need to prove your company’s worth. In the exact opposite situation – selling or stepping back from your business – you should know your company’s value so you know how much you can get for your business and what you can potentially earn from the transaction.
The below metrics are among the best measures of good financial standing for a company:
You can use the below indicators to tell if your company is doing well financially:
Revenue is the amount of money a company receives in exchange for its goods and services. The revenue received by a company is usually listed on the first line of the income statement as revenue, sales, net sales, or net revenue. (For help creating an income statement, visit the SmartBiz Blog: How to Prepare an Income Statement.)
Depending on your industry, there are tried and true ways you can increase your business revenue.
Although expenses will increase as your business expands, they should be in sync. For example, if you experience a revenue increase of 5% year over year, you don’t want your expenses to exceed that percentage. In order to stay on top of expenses and how they relate to revenue, keep on top of your business expenses.
Our article, How to Keep Track of Business Expenses, gives 4 steps about how to track accurately. Tips include keeping personal and business expenses separate, choosing the right method to calculate, and keeping an eye on tax deductible expenses.
A low cash balance, perhaps as indicated on a cash flow statement, is an indicator of a company that isn’t doing well financially. Revenue could be increasing but if you just reinvest into the company, you’ll find yourself cash poor. For example, if you need additional inventory, equipment, or staffing, you won’t be in a position to cover those costs. Poor cash flow is one of the main reasons for small business failure. The SmartBiz blog has a number of articles that can help here.
This formula measures how much your business owes vs. how much your business is worth and is expressed as a decimal or percentage.
According to Investopedia, a ratio greater than 1 shows that a considerable portion of debt is funded by assets. In other words, the company has more liabilities than assets. A high ratio also indicates that a company may be putting itself at a risk of default on its loans if interest rates rise suddenly. A ratio below 1 shows that a greater portion of a company's assets is funded by equity.
A profitability ratio measures your company’s performance related to the capacity to make a profit. Profit is defined as what is left over from income earned after you have deducted all costs and expenses related to earning the income.
Common profitability ratios include gross profit margin, operating margin, return on assets, return on equity, return on sales and return on investment. To learn more about these ratios and how to calculate, review study.com’s comprehensive article here.
This ratio measures how your business manages its assets. There are several ways to calculate how your business is doing in this area:
Acquiring a new customer can cost five times more than retaining an existing customer. The success rate of selling to a customer you already have is 60-70%, while the success rate of selling to a new customer is 5-20%, according to ClickZ. Having a stream of both new and existing customers is an indication of business health. Every business loses customers so you need a healthy pipeline of new consumer purchasing your product or service to take their place.
A company’s operating profit margin, also referred to as its return on sales, measures the proportion of income to revenue. This number reveals how much profit your business is generating from sales and can help you set goals and gauge your progress. Lenders may require you to present your business’s profit margin to get a sense of financial health.
There are two main types of profit margins small business owners can use to calculate: gross profit margin and net profit margin. Read What Is a Good Profit Margin for a Small Business? on the SmartBiz blog to learn how to calculate.
By looking at your cost of goods sold (COGS), you can see just how much money you need to spend to keep operating in a financially healthy way.
According to the Bench Blog, COGS is the cost your business spent acquiring or producing items that you’ve already sold to your customers. Here’s how to calculate COGS:
COGS = Beginning Inventory + Inventory Purchases – Ending Inventory
From here, use this number to calculate gross margin, net sales revenue minus its cost of goods sold (COGS).
When looking at your inventory numbers, pay attention to shrinkage, the loss of inventory attributed to factors such as employee theft, shoplifting, administrative error, vendor fraud, damage in transit, or in-store and cashier errors. Keep accurate records to track inventory loss and put systems in place to combat it.
Through financial ratio analysis, you can determine what the line items in your financial statements tell you about your company’s solvency, operational efficiency, and liquidation value. This makes financial ratio analysis a quick way to value your company.
That said, you should always make sure to calculate several ratio values instead of just one. That’s because, on their own, individual ratios tell you next to nothing about your finances. Investopedia explains this distinction while listing several types of important financial ratios.
Since your company’s balance sheet attests to its short-term or instantaneous financial picture, it’s an easy reference point for determining whether your company is doing well financially. For a quick valuation, just subtract your total liabilities line item from your total assets line item. The result is effectively your bottom line and thus your company’s value. Learn more via the SmartBiz Loans blog: How to Create a Balance Sheet for Your Business.
An income statement is an extremely comprehensive financial statement that includes key valuation line items such as net income and the cost of goods sold. Your net income is perhaps your clearest indicator of whether you’re doing well financially. If your net income is low or negative, you can strategize how to lower your cost of sales for more profits.
Business owners such as yourself should especially pay attention to what you see in your income statement – few documents provide such meaningful overviews of your financial situation. Learn more via the SmartBiz Loans blog: Example of Income Statement, Format and Structure.
Not every entrepreneur has the knowledge or time to handle the financial tasks needed to run a successful business. If you find yourself in need of some assistance, consider hiring an outside accountant or bookkeeper. As Richard Branson famously said, “If you really want to grow as an entrepreneur, you’ve got to learn to delegate”.
Our article, How to Hire an Accountant for Your Small Business, dives into signs you need an accountant, services provided by an accountant, and how to determine if you need to hire for a staff position or a contractor.
Are you seeking outside funds to spark growth? Lenders look at specific ratios to determine the health of your business. Those ratios include: