5 Financial Metrics Every Small Business Owner Should Monitor

If you’re anything like me, you started your business with a vision and enthusiasm. We pour our hearts into our ventures, hustling day in and day out to turn dreams into reality.?

But here’s the truth: passion and hard work alone aren’t enough to ensure long-term success.?

The numbers often tell us the real story of how our businesses are doing– the objective, down-to-earth financial metrics that can be any enterprise’s making or breaking point.

You wouldn’t drive a car without ever looking at the dashboard, would you??

Similarly, you should regularly monitor its financial health to run a business. Many small business owners avoid looking at these numbers too closely because it can be complicated and overwhelming, especially if you don’t have a business coach by your side to understand what it all means.?

But I’ve learned over the years that these numbers are our friends—they guide and warn us so we can react with the business’s best interest at heart.?

This blog post will focus on the five essential financial metrics that every small business owner should be tracking.?

Cash Flow

Definition and Importance

Cash flow represents the money coming in and going out of your business. Think of it as the business’s heartbeat.?

A healthy, steady beat means things are running smoothly, but irregularities can signal problems that need immediate attention.?

Your business needs a positive cash flow to operate day-to-day—paying bills, buying inventory, covering employee salaries, and growing.

Positive vs Negative Cash Flow

A positive cash flow is when more money comes into your business than going out. This surplus can be invested back into your business to accelerate growth or set aside for a rainy day.?

Conversely, a negative cash flow means more money is leaving your business than what’s coming in.?

We’ve all been there, and it’s not a great place. Prolonged negative cash flow is a warning signal you can’t afford to ignore, as it may lead to insolvency.

Monitoring Tips

• Regularly update your cash flow statement. This document outlines all your cash inflows and outflows. Depending on your business needs, you can update it weekly, bi-weekly, or monthly.
• There are plenty of user-friendly accounting tools designed for small business owners that can help you track cash flow automatically.
• Sometimes, it’s worth getting an expert’s perspective. A financial advisor can provide personalized insights and proactive strategies to manage and improve your cash flow.

Profit Margin

Definition and Importance

Profit margin is a measure of profitability, calculated as a percentage of your revenue that exceeds your costs. In other words, it’s not just about how much money you make but how much you get to keep after covering expenses.

Types of Profit Margins

Understanding profit margin gets more nuanced when we dig into its types. Mainly, there are three you should be aware of:

Gross profit margin focuses on the direct costs of making your product or delivering your service. Gross profit margin gives you an idea of how efficiently your business produces and sells products.

Operating profit margin accounts for operational expenses like wages, rent, and utilities. It’s a good indicator of how well you manage your business costs relative to your income.

Net profit margin is the granddaddy of them all. It considers all expenses, including taxes, interest, and depreciation, to tell you how effectively your business turns revenue into actual profit.

Improving Profit Margin

• Negotiate with your supplies. The less you spend on your raw materials or products, the higher your gross profit margin will be.
• Optimize operational efficiencies and look for ways to streamline your processes, whether automating specific tasks or revising your staffing levels.?
• Adjust pricing strategies. Sometimes, a slight price increase can significantly boost your profit margins, especially if it doesn’t adversely affect sales volume.

Return on Investment (ROI)

Definition and Importance

ROI evaluates the gain or loss generated on an investment relative to its cost. In the language of small business owners like us, it answers the question: “Was this worth it?”

Calculating ROI

Math alert! But don’t worry, the ROI formula is straightforward:

ROI = (Net Profit from Investment – Cost of Investment) / Cost of Investment

So, let’s say you invested $5,000 in a marketing campaign and earned $15,000 in sales from it. The ROI would be:

• ROI = ($15,000 – $5,000) / $5,000
• ROI = $10,000 / $5,000
• ROI = 2 or 200%

This result means you earned twice as much as you spent, which is a good deal if you ask me.?

How to Increase ROI

• Before making any investment, weigh the expected benefits against the costs. The higher the anticipated ROI, the better the investment.
• Don’t just set it and forget it. Continuously monitor the ROI of your various investments, whether it’s a new product line, an advertising campaign, or new equipment.
• Keep detailed records of past investments and their ROIs. This historical data can guide future investment decisions and help you avoid previous mistakes.

Current Ratio

Definition and Importance

Next up on our financial dashboard is the current ratio, a liquidity ratio that helps you understand if your business has enough assets to cover its short-term liabilities. In layman’s terms, it answers the question: “Can I pay my bills?”?

Interpreting the Ratio

Divide your current assets by your current liabilities to calculate the current ratio. A current ratio of 1 means you have enough to cover your short-term obligations, but more often than not, you’d ideally want this number to be between 1.5 and 3.

High Ratio: A very high ratio (much greater than 3) could indicate you’re not effectively using your assets to generate revenue.

Low Ratio: A ratio under 1 is a red flag that you might struggle to cover short-term liabilities and face liquidity issues.

Best Practices

• Too much unsold inventory can tie up assets. Aim to have just enough to meet demand without going overboard.
• Make sure you’re invoicing customers promptly and following up on unpaid invoices. Money tied up in accounts receivable isn’t helping your current ratio.
• Negotiate with suppliers for longer payment terms to decrease your current liabilities, improving your current ratio.

Debt-to-Equity Ratio

Definition and Importance

The debt-to-equity ratio compares your total debt to your total equity. It provides insight into how you fund your operations and growth via debt or your own funds (equity).?

Healthy vs. Unhealthy Ratios

The ideal Debt-to-Equity Ratio can vary by industry, but generally speaking:

A high debt-to-equity ratio often means that a business has aggressively financed its growth with debt, which could be risky if the revenue doesn’t exceed the cost of debt.

A low debt-to-equity ratio typically suggests a more conservative approach, relying more on equity for financing. While less risky, it might mean you’re not taking full advantage of leveraging other people’s money to grow.

How to Improve Your Debt-to-Equity Ratio

• This tip might sound obvious, but the less debt you have, the lower your debt-to-equity ratio will be.
• Instead of distributing all profits as dividends or owner’s draws, consider retaining some earnings to improve your equity and, consequently, your debt-to-equity ratio.
• Before taking on additional debt, consider its impact on your debt-to-equity ratio and whether it aligns with your financial strategy.

Final Thoughts

Financial metrics can feel overwhelming. Trust me, I’ve been there—scratching my head over ratios and percentages, wondering if I’m making sound business decisions. But once you get a grip on these key financial metrics, you not only take control of your small business’s financial health and set yourself up for sustainable growth.

However, every business has its own challenges and opportunities, and that’s where personalized coaching comes into play.?

Lori Moen of Catalyst Group ECR offers insights tailored to your specific situation, something generic advice can’t provide. Let us guide you through it, giving personalized strategies to improve your financial indicators and, ultimately, your business’s success.

Ready to take the next step? Click here to schedule a free consultation and see how our coaching services can benefit you.