Know your numbers
As a business owner, it’s important to know your company’s financial health at all times. But it can be overwhelming to decipher financial documents. In our first article of the Financial Foundations series, we’ve gathered seven financial indicators to track to help you gauge your business progress, guide operational decisions and set goals for long-term success.
The basics of metrics and KPIs
Before we dive into the top financial indicators you should track, let’s do a quick review of metrics and KPIs (key performance indicators). Metrics are any quantifiable data that companies monitor to track performance and improvements. They create a baseline so you can compare future numbers to see how performance has changed over time.
KPIs are the key metrics that are important to your business and impact whether your company thrives or struggles. They typically have predetermined goals, which differentiates them from metrics. While metrics and KPIs can be tracked for almost anything, we’re going to focus on financials.
1. Operating cash flow
One of the best financial KPIs to track is your operating cash flow. It's the amount of cash your business generates from core operational activities, like providing services, selling and purchasing inventory, and paying staff. Operating cash flow shows whether your business is earning enough to keep operating.
There are two ways to calculate your operating cash flow: direct and indirect. The direct method is simpler but gives you a good idea of your business’s profitability, while the indirect method considers factors such as depreciation, accounts receivable and accounts payable.
Operating cash flow = total revenue - operating expenses
Operating cash flow = net income + noncash expenses ± changes in working capital
2. Cash flow to debt
Keep an eye on your cash flow to ensure you can repay debts with the cash flow-to-debt ratio. This helpful metric will tell you whether you can cover your bills without having to secure additional funds. Be aware that a cash flow-to-debt ratio of less than one is a sign that you won’t be able to pay your debts.
Cash flow-to-debt ratio = (net income + depreciation) ÷ total debt
3. Earnings before interests and taxes (EBIT)
EBIT is used as a profitability measurement of your core business operations by calculating earnings before interest and taxes. It allows you to compare your business to other similar businesses in your industry and see where you’re making money.
EBIT = revenue - cost of goods sold - operating expenses
4. Working capital
The amount of money your business has available to pay for daily functions and short-term debts is your working capital. Assets (e.g., cash, accounts receivable, inventory) and liabilities (e.g., accounts payable, taxes, lines of credit) are considered within this equation.
Working capital = current assets - current liabilities
5. Accounts receivable turnover
Accounts receivable turnover measures how timely your company is being paid once a sale has been made. If the turnover is high, you want to focus on your accounts receivable process so you can get paid on time and keep your cash flow consistent.
Accounts receivable turnover = (total outstanding accounts receivable ÷ total sales) × number of days
6. Accounts payable turnover
Do you know how long it takes for your business to pay its bills and invoices? Use the accounts payable metric to see how quickly you’re paying your bills. The higher the ratio, the shorter amount of time it takes for you to pay invoices. It’s also a good sign for creditors and investors as it’s an indicator your business has less debt on its books.
Accounts payable turnover ratio = average number of days ÷ 365
If you want to convert the turnover to days, use the formula below:
Accounts payable turnover in days = 365 ÷ payable tunover ratio
7. Average customer acquisition cost
Use the average customer acquisition cost to uncover how much your business spends (on average) to add new customers during a certain period of time. This metric accounts for expenses in marketing, payroll, technology and more, and can help you determine whether your business model is sustainable.
Average customer acquisition cost = (cost of sales + cost of marketing) ÷ new customers acquired
Keep it simple
Before you concern yourself with keeping up with multiple calculations in a spreadsheet, know that there are several financial and accounting applications that will automatically track these numbers for you. Knowing your numbers using metrics and defining KPIs will help your business stay on track toward success.Back to issue