4 Financial Yardsticks for Your Small Business
How do you measure the success of your company? If you’re like many small-business owners, you rely on two traditional financial reports: the balance sheet and the income statement. The first tells you what your business owns and owes at a particular point in time, and the second tells you what profit you’ve made over a period of time.
Although both remain important, four other tools and metrics can help you gauge how your business is faring.
1. Cash-flow statement — The cash-flow statement is often treated as the red-headed stepchild of the two main financial reports, but it provides more information than either one. If you’ve ever wondered at the end of the year where all the money went, then this is the report for you.
The cash-flow statement takes your bank balance from your balance sheet at the beginning of the year and shows you the cash inflows and outflows that led to your bank balance at the end of the year. It shows how much you received in net income, plus all of your receipts and payments that increased or decreased what your business owns and owes. It can tell you why you are feeling a financial pinch (increases in accounts receivable or inventory, pay down of debt) or why you might be hitting the financial rocks in the near future (increases in payables, new debt financing).
2. Accounts receivable collections — Cash flow in any business depends upon the collection of receivables in a timely fashion, thereby completing the sales cycle. As your receivables grow, your cash flow can be stretched ever thinner. Knowing the number of days, on average, that it takes to collect your receivables is the first step in identifying any negative patterns.
To calculate the average number of days that sales are in receivables, begin by dividing your annual sales by your accounts receivable. In accounting-speak, this is called your receivables turnover. To get the number of days, divide 365 by the receivables turnover. For example, if your sales are $100,000 and your receivables balance is $19,000, your receivables turnover is $100,000/$19,000 = 5.26. Your days in receivables are 365/5.26 = 69. This tells you that, on average, it takes you 69 days to collect your receivables. If your official terms are net 30, this means that your collection process is not working. If your days in receivables gets longer over time, your business is heading in the wrong direction.
3. Average sales per customer — When growing your company’s sales, it makes sense to grow the amount you sell to existing customers (which is often easier than finding new ones).
Following trends in your average sales per customer is a helpful analytical tool for measuring whether you’re successfully encouraging repeat business.
Average sales per customer is simply calculated as your total annual sales divided by your total number of customers. To make the benchmark more accurate, exclude any unusually large orders from your total sales and exclude anyone who did not purchase from you in the year in question from your customer count. The goal is for your average sales per customer to increase year over year. If it is not, examine your marketing and promotion strategy to find ways to sell more to your existing base. This can also be calculated on a quarterly basis to give you more timely information to work with.
4. Net margin percentage — It can be easy to focus on the revenue line in your income statement and be content that the figure increases each year. What’s more important, however, is that your revenues don’t cost more to garner each year. Analyzing your profitability over time helps you to ensure that you are increasing the bottom line at a steady or increasing pace.
Profitability is calculated as net income (revenues minus expenses) divided by sales and is expressed as a percentage. For example, if your sales are $100,000 and your net income is $15,000, your net margin percentage is $15,000/$100,000 = 15 percent. If your net margin percentage starts to decline as your revenues go up, the increase in business may bebecoming less profitable and you need to examine your cost structure.