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 9 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.
1. Growing revenue
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.
- Increase the number of customers: In short, bring more business in the door. Even if transaction sizes stay the same, more customers = more revenue.
- Increase the frequency of transactions: This means encouraging people to purchase from you more often. If your average customer comes in once a month, convincing them to patronize your business once a week will increase your revenue.
- Upsell: This is when you encourage your customer to purchase more of your goods or services. For example, if you own a beauty salon, suggest a manicure in addition to a haircut. If you own a restaurant, upsell additional purchases like drinks, appetizers, or a dessert.
- Raise prices: If your prices go up, you’ll collect more revenue from every purchase a customer makes – with the same amount of effort.
2. Expenses stay flat
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.
3. Cash balance
A low cash balance 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.
4. Debt ratio
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.
5. Profitability ratio
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.
6. Activity ratio
This ratio measures how your business manages its assets. There are several ways to calculate how your business is doing in this area:
- Asset Turnover: This calculation is sales divided by assets. Strive for a high asset turnover ratio.
- Inventory Turnover: A high inventory turnover ratio indicates positive management of inventory. Calculate by dividing your cost of sales average inventory.
- Operating Expense Ratio: Divide operating expenses by total revenue to determine how much you must spend to generate revenue. Strive for a low ratio.
7. New clients and repeat customers
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.
8. Profit margins are high
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.
9. Spending on inventory
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. For an in-depth look at how to prevent shrinkage, visit the SmartBiz Small Business Blog: How to Prevent Shrinkage.
If you need help
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:
- Combined Debt Coverage
- Business Debt Coverage
- Business Credit
- Personal Credit
- Business Debt Usage
- Personal Debt Usage
- Business Revenue Trend
If these ratios indicate that you’re in good shape, you’re much more likely to qualify for low-cost funds when you need them.
But you don’t need an advanced financial degree to calculate, SmartBiz Advisor does it for you. This free online tool was created to help business owners determine where they stand before applying for funding. In addition to generating your unique Loan Ready Score, the Advisor tool recommends ways to help you increase your credit and financial health, if needed.