The success of a business largely depends on the ability of the decision makers to make the right decisions at the right times. Making the right decision, on the other hand, requires a good grasp of the different moving parts of the business, especially with regards to how the finances of the company is moving in or out.
To be able to do this effectively, financial metrics provide simple but key measurable indices that help you closely monitor important aspects of a business. This is why every business owner must, as a matter of priority, master the art and science of studying and understanding financial metrics. In this article, we shall provide a simple introduction that will help you get the basics of this subject and even build on it.
Examples of Important Financial Metrics for Businesses
Since this is just an introduction, we will quickly list and discuss some examples of financial metrics that you can start with. If you want to do some personal research, you can visit https://signatureanalytics.com/financial-metrics/ for more information. For now, we will look at these few factors which we consider to be some of the most important indicators to watch.
This of course is an important factor for any business. Revenue generally describes any funds that come into the company. We can break these into the following:
- Gross Revenue – This refers to total amount of all the revenue that come in from the sales of goods and services before deductions for cost of goods and other associated expenses and taxes.
- Net Revenue – While gross revenue describes the sum total of income before any deductions, net revenue refers to what is left after all deductions (cost of goods, taxes, and other expenses) have been made.
- Revenue Growth Rate – This is a measure of the growth or decline in revenue over a given period. This can be over a period of a financial year or quarter.
- Customer Acquisition Cost – This is a measure of how much it costs the company to acquire a new client or customer. This can include costs for adverts, promotions and other efforts targeted at attracting new customers.
- Customer Lifetime Value – This is an approximation of the revenue that a business can expect to earn from a single customer over the period of their mutual relationship. This value is arrived at by subtracting the cost of serving the customer from the total earned from them.
Just as with revenue, profitability is a key factor in the measure of a company’s success or lack it. Since there are a number of different moving parts involved, this metrics can be measured under the following headings:
- Gross Profit Margin – This is the first stage in calculating the profit of a company. It represents the percentage of the revenue left after the cost of the goods or cost of rendering the service is deducted from the revenue generated.
- Net Profit Margin – This is shows the percentage of the revenue that is the real profit. This is because, in addition to subtracting the cost of the goods, we also subtract all other associated costs, leaving us with the real profit.
- Return on Investment – Aside from the delivery of goods and services, many businesses diversify by investing some of their profits in other ventures or investment vehicles. This index shows the profit or loss made on such investments.
- Break-even Point – This index shows how much sales the business needs to make or had to make to earn revenue that matched its expenses, resulting in neither a loss or gain.
- Cash Flow – This is an indicator of how much cash a business has available after removing its running costs from revenue received within the same period. A business can have a negative or positive cash flow.
When a business needs to raise funds to meet some financial obligations because of falling revenue or any other reason, it may have to quickly convert some of its assets to cash. The ease with which this can be done is what this metrics will be measuring.
We will look at this under the following classes:
- Current Ratio – This index is used to determine if the business can meet its short-term obligations with its current assets. The formula used is “current asset/current liability.” So for example, a 1:1 ratio means that the current assets will meet the short-term obligations. A 1:2 ratio will mean that you will require twice the value of the current asset to meet the short-term obligations.
- Quick Ratio – This is a slightly different index which is thought to give an even more realistic outlook to an organization’s ability to meet its short time liabilities. In this case, the current assets considered do not include the inventory as inventory is not regarded as an easy-to-liquidate asset. The formula for this is (Cash + Accounts Receivable + Marketable Securities) / Current Liabilities.
- Operating Cash Flow Ratio – This metric is used to determine how much of the organization’s current liabilities can be taken care of by its income. To get this information, this formula is used: Operating Cash Flow / Current Liabilities.
- Days sales outstanding (DSO) – This metric provides information on how long it takes to get payment from customers/clients for goods purchased or services rendered.
- Inventory Turnover – This metric is used to determine how long it takes the company to sell off and restock its inventory over a given period.
Finally, we will look at this last parameter that should make up a robust financial metric for any business. This factor will be broken down into the following:
- Asset Turnover – This shows you the efficiency with which a business uses its assets to generate revenue.
- Accounts Payable Turnover – This is a measure of how quickly the business fulfills its financial obligations to its suppliers or service providers.
- Accounts Receivable Turnover – Similar to DSO under “Liquidity” above, this metric shows how quickly the business collects payments from its customers.
- Inventory Turnover – This is the same as “Inventory Turnover” mentioned under “Liquidity” above.
- Working Capital Turnover – This is a measure of the efficiency with which revenue is generated with the available capital.
What we’ve looked at are just some of the major financial KPI or metrics that any business owner needs to be watching out for. While you can expand on them as you can see here, these are sufficient for most small to medium businesses.
Running a business venture to be profitable is a function of deliberate steps taking after informed decisions have been made. You can only make informed decisions when you have properly distilled data available for consideration. This article has provided a simple introduction that any business owner can build upon to help them begin to generate better data to enable them make better decisions.