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Business metrics 6 min read

4 key financial metrics for business

If you can't measure it, you can't improve it. These tried-and-true indicators can help gauge your business' success and tip the financial scale in your favour.

Every business will have its own financial metrics to indicate how well they are doing. Perhaps most have sales at the top of the list, as it’s easy to measure and (usually) indicates how well a business is doing. Sometimes your business problems can be solved if you tip more money at the top of the sales funnel. But not always.

Increasing sales may conceal tell-tale signs of future issues such as margins starting to slip, overheads swelling or deterioration of debt to equity. One way to avoid future unpleasant surprises is to set financial triggers or drivers so you can monitor the performance of your business.

Here are four financial metrics you may like to start tracking and improving.

 

1. Gross margin

Gross margin is the difference between what you pay for inventory, raw materials or people and the price you charge customers. Common causes of a falling margin include losing money on specific products or services, discounting to compete with the competition, theft and wastage in the production cycle, or declining billed time. Gross margin is a critical metric, as it’s an early warning system that one or many parts of your business are deteriorating. 

 

  • Increasing prices. It’s the best way to improve your margin overnight, as the extra dollars flow straight to the bottom line without any additional costs or work. Choose items that have low price sensitivity. Even slight changes can have a big impact on maintaining margin.
  • Lowering the cost of supply. Find cheaper alternatives without affecting quality, ask suppliers to reassess their pricing, or take advantage of discounts through bulk buying.
  • Identify efficiencies, such as speeding up output, introducing lean manufacturing techniques and tightening slippage from stolen, broken, or returned products.
  • Concentrate on selling products and services that have the largest individual margins and phase out anything with a low margin.
  • Target customers who may pay more.  

 


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2. Revenue from existing customers

Increasing the number of things customers buy from you will improve revenue. It can be products, hours, services, warranties, insurance, or anything that encourages a customer to buy two or more things rather than one. You can also build average revenue by identifying what your best customers are buying, thinking of other products or services that could be bundled with them, and tailoring special offers to bring these customers in more often.

 

Other ideas include:

  • Focus on your ‘gold’ customers – those responsible for high, profitable sales. Target the ones with the most potential and then develop a specific proactive plan for each of them.
  • Use inbound CRM software to better predict clients that are more likely to buy, and set up lead generator tools or content to gather interested prospects to follow up.
  • Create a marketing plan to identify, locate and sell to new customers.
  • Look for new distribution channels to expand your customer bases, such as your website and third-party selling sites (for example, Amazon, ebay, iTunes).  

Steady revenue growth from existing customers is the sign of a healthy business, as it validates what you sell is valued again and again.

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3. Cash on hand to cover obligations

If you can’t pay your bills, it’s hard to stay in business. Measuring your liquidity or working capital (cash on hand or assets that can be converted easily into cash like inventory) is a key metric to meet short-term obligations, such as paying supplier invoices, wages, rent and any loan payments.


Use your accounting software or set a minimum cash balance, to alert when outgoings may exceed cash available.

 

To correct any issues: 

  • Amend your terms of trade so funds are collected faster.
  • Offer immediate payment discounts to customers if the situation is dire.
  • Identify if inventory or raw materials are being overordered.
  • Only buy what you need. Move to ‘just-in-time’ ordering to better match your invoicing schedule. It can be tempting to order in bulk and receive a volume discount, but it does eat into your cash.
  • Make it easy for customers to pay you. Find out more about our managing receivables services.
  • Follow up on any outstanding invoices owed to you.
  • Conduct a stock audit to see if you have any out-of-date or poor-selling stock. If you do, clear it out.

Don’t buy significant assets out of day-to-day operating cash if it places stress on your capital. There are financing options such as leases or loans to spread the cost over the years of use.

You can also check expenses are not ballooning ahead of sales, which can happen if you’re growing and inefficiencies creep in. Each month, divide monthly sales by monthly expenses. For example:

  • You have $50,000 in expenses.
  • You’ve made $500,000 in sales

500,000/50,000 = 10

If the ratio figure (10) decreases month over month, it indicates it’s costing you more to generate each sale.

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4. Your industry ratios

It’s always worth measuring the vital financial metrics involved in your industry, as each will have a different emphasis. If you are a service business and do not sell products (like a lawyer or accountant, for example) then the gross margin isn’t as useful to track. Instead, monitoring your salaries paid to sales ratio (for example, if salaries comprised 35% of overall sales) might be more valuable to you.


Some examples:

  • Retailers may want to track inventory turnover (how fast inventory moves through the business). Slowing down can hint at unsold stock. Sales per employee, the conversion rate and average sale value are also useful, to check the efficacy of employees on the shop floor.
  • Professional businesses may want to ensure staff earn their share of revenue. One way to find out is by setting monthly revenue that is billable per team member (often common with accountants and lawyers). If the business is software or subscription-based, the monthly recurring revenue (MRR) is an excellent test of how well the business is performing.
  • Construction companies with large projects may want to measure profit per project, gross margins, wages to revenue, cost per metre, or the productivity of employees.

Find out your industry’s main key financial performance indicators and decide what you want to measure.

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Summary

As a business, it makes sense to know what financial metrics indicate you’re doing well, or not. Deciding what these red flags are and then monitoring regularly, will allow you to detect early what remedies need to be put in place.

 

Next steps

  • Discuss with your accountant or financial advisor the most appropriate financial metrics for your business and set up warning alerts to trigger action.
  • Contact your industry association to see if they have suggested metrics. If you can, find out any industry averages so you can then benchmark your data. For example, if you have a stable gross margin of 25 per cent, that’s good if everyone else is at 20 per cent, not so good if the norm is 40 per cent.
  • Talk to key staff and involve them in the process. Explain the benefits (maybe offer incentives), so they feel part of the solution.
  • Connect with a CWB Relationship Manager if you have any financial questions related to your business.