Is your business financially healthy? The real answer depends on much more than your current bank account balance or revenue generated last month.
If you’re uncertain about what financial information you should be watching in your business (never mind what insight you’re supposed to glean from those numbers), keep reading to discover the 10 critical financial numbers that every business owner should know.
Critical Number 1: Annual Revenue
When your company is growing rapidly, it’s easy to let your bookkeeping and financial tracking slide a bit. But one of the biggest mistakes you can make is not keeping track of annual revenue.
Here’s why: Annual revenue is one of the best indicators of your company’s health. Tracking your year-to-year growth is an easy way to get a feel for which direction your company is headed. Generally speaking, the larger the number, the better your company is doing.
To accurately assess this key financial number, identify:
- Your annual revenue from last fiscal year
- Your annual revenue from two fiscal years ago
- Your revenue for the current fiscal year, annualized
By glancing at these 3 numbers, you can quickly assess whether your company is expanding or shrinking – and whether you’re on track to achieve the revenue goal you set for this year.
Critical Number 2: Gross Profit
As many business owners have discovered, though, revenue isn’t the only number that matters. Equally important is Gross Profit, which is the amount of profit that you can directly attribute to the product or service sold.
Calculating Gross Profit is simple. Start with the price at which you sold your product or service. Then subtract the direct expenses associated with that particular product or service.
For example, if you made $300,000 in revenue last month and had $200,000 in expenses, your gross profit is $100,000.
Generating a profit is essential to a healthy business. After all, it’s possible to increase revenue, but still lose money. Tracking your Gross Profit will help you spot when there is an issue brewing.
To keep a finger on the pulse of your business, assess and monitor this number as a percentage of revenue. To calculate your Gross Profit Percentage (GPP), divide the gross profit by the total revenue. In our example, the GPP is 33 percent ($100,000 divided by $300,000).
To spot trends, compare your current year’s GPP to the GPP from the last fiscal year, as well as two fiscal years ago.
Critical Number 3: Net Profit
Diving deeper into our numbers, you’ll also want to know your Net Profit.
Net Profit is the amount of your profit left afterpaying all of your expenses, not just the ones associated with producing the goods and services you sold. These additional expenses include overhead for items not specifically related to the cost of your products and/or services.
As with Annual Revenue and Gross Profit, monitor your Net Profit as a percentage of revenue (Net Profit divided by Annual Revenue). You’ll also want to track it against previous data from the previous two years, as well as against the NP goal you set for this year.
A shrinking Net Profit can be caused by a few factors. Your operating expenses might be growing, which means you should review them to see what you could trim. But if your operating expenses are reasonable, it could mean that your annual revenue isn’t at the level it should be.
Critical Number 4: Gross Profit and Net Profit Compared to Industry Averages
We recommend monitoring the current year’s Gross Profit and Net Profit as compared to the previous two years’ performance so that it becomes easier to spot trends in your business.
However, this produces limited insight because it benchmarks your performance only against your own company’s earlier results. If you want to know how your company is performing compared to its potential, expand your scope by comparing your performance to your industry’s averages.
To do this, start by identifying your North American Industry Classification (NAICS) code. Knowing your NAICS code allows you to research statistics for your industry. Use this additional information to gauge your company’s overall health and set annual performance goals. You can even use it to secure additional financing from lenders by demonstrating how well you’re faring as compared to competitors.
Critical Number 5: Monthly Operating Expenses
As we saw when discussing Net Profit, operating expenses are something to watch. This category of expenses includes anything not directly attributable to producing and delivering your products and services, such as rent, utilities, office supplies, and salaries.
How much is too much when it comes to operating your business? A helpful guideline is to spend no more than 30 percent of your annual budgeted revenue on operating expenses.
Monitoring this number will help you spot areas in which you might be wasting money (e.g., where you might be able to trim expenses). You’ll also get an idea for how much cash you need to have on hand to get through months when revenue is lower.
Critical Number 6: Monthly Break-Even Sales Figure
What’s the minimum amount of money you need to make in a month? Many business owners mistakenly believe that their minimum target is equal to their operating expenses.
In fact, it’s a bigger number that depends on the Gross Profit you generate from those sales. Remember, every dollar you bring in isn’t pure profit. You have costs associated with producing your products and services. Only the money left after deducting those expenses – your Gross Profit – can be put toward operating expenses.
To calculate your monthly break-even sales figure — the minimum sales you need to generate each month to produce enough profit to cover your operating expenses — divide your operating expenses by the Gross Profit Percentage. This gives you a realistic targetat which to aim each month to ensure that you don’t suffer losses by year end.
When discussing GPP above (Critical Number 2), our example GPP was 33 percent. Let’s say that our operating expenses are $50,000 per month.
To calculate our minimum monthly expenses, we’ll divide $50,000 by the GPP of 33 percent. This simple calculation reveals that we need to generate $151,515 in sales each month to generate enough Gross Profit to cover our monthly expenses.
That’s a significantly bigger target than aiming for $50,000 to cover operating expenses, isn’t it?
Critical Number 7: Monthly Cash Flow from Operations
One of the most shocking secrets of financial management is that companies of all sizes experience cash flow issues. Understanding cash flow and monitoring how it moves through your business is essential to your company’s financial health.
Calculating cash flow from operations is as simple adding up your Net Profit plus all non-cash expenses that were recorded. These expenses include anything that you do not have to pay cash for, such as depreciation.
If you have assets that are being depreciated over several years, the depreciation that is attributed to the current period gets recorded as an expense in the current period and deducted from revenue. This leaves a reduced Net Profit that assumes the depreciation was paid.
However, if you are not working in an all-cash environment — meaning you do not sell on accounts receivables, and you pay your vendors on delivery — then you need to take the added step of treating your operating cycle as a mitigating factor in your cash flow management.
If cash flow is tight, your cash flow forecast should list out anticipated weekly cash flow for the next 13 weeks. If cash flow is comfortable, you can do a monthly cash flow that looks at the next 13 months. Having these numbers at your fingertips will help you anticipate and take action to avoid cash flow crunches.
Critical Number 8: Length of Operating Cycle
To successfully guide your company through lean times, it’s important to know what your operating cycle is.
Your operating cycle is the length of time between when you start to expend funds on creating or delivering a product or service and when you collect payment for selling those products or services. Many business owners assume an operating cycle of about one month, but in reality, their cycle may be far longer – 50, 70, even 90 days or more.
If your operating cycle starts to increase, investigate and take corrective action. Perhaps customers are taking longer to pay their invoices, which might be an early warning sign of a slowdown in your industry or a sign that you need to improve your collections process. Or perhaps it is taking longer to produce your product or service, which might be due to poor inventory management of key components or inefficient production.
Critical Number 9: Desired Minimum Cash Balance
How much money should you keep on hand in case of a cash flow crunch? Many business owners think it should be enough to cover a month’s worth of operating expenses.
The real answer, however, is having enough cash available to float you through an entire operating cycle, which can be much longer than 30 days. You need adequate cash reserves to pay for the purchase of goods, payment of payroll and operating expenses, and shipment of goods to the customers while you are waiting for customers to pay.
Identify what your desired minimum cash balance is and track how much you actually have on hand. Minor fluctuation in your minimum cash balance is normal. But you want to ensure you have the minimum cash balance available most of the time. If you notice a downward trend in this number, act quickly to address it.
Critical Number 10: Line of Credit
If you’re realizing that your business doesn’t have adequate cash reserves to cover a full operating cycle, don’t worry. Many business owners find themselves in this position, especially if these 10 critical numbers are a new way of assess business health.
Protecting your business is as simple as establishing a line of credit with a financial lender. Your goal is to secure a line of credit that, when combined with your cash reserves, will total an amount that can cover your full operating cycle.
When determining whether to award you a line of credit, lenders want to know that you will be a good steward of their money. They will want to see proof that your business is financially healthy – and that you’ll be in a position to pay them back.
To improve your chances of securing a line of credit, make sure that your financial statements are in order and presented in a way that makes your company look good. Getting a handle on these 10 key financial numbers is an excellent place to start.
Use These 10 Numbers to Steer Your Company to Success
As a business owner, you do not have to be a financial expert to effectively manage a company. But understanding these 10 critical numbers in particular — and how they impact your business — will build your confidence, make it easier to manage your company, empower you to make sound financial decisions, and navigate a clear path to sustainable growth.
Want help assessing your numbers and identifying the best ways to get your business on firmer financial footing? Schedule a complimentary, no-obligation Financial Strategies & Solutions Session with one of our highly trained virtual CFOs.