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Do you know why financial metrics are critical for a small business? Every business is started with the aim to develop into a large-scale enterprise and expand widely. Thus, entrepreneurs and business owners start their businesses with this lofty goal but find themselves unable to achieve what they started out to do. The most important reason why this happens is because of the lack of validated information, which is necessary to make good decisions.
To arrive at the correct decisions, an entrepreneur or business owner should be well-versed with the numbers that make a difference to his or her business. Usually, business owners are people who have converted their hobby or passion into a full-fledged business. Thus, keeping a track of numbers and metrics is generally an alien concept for them.
Each business is measured using a few key performance indicators (KPIs), such as cash flow metrics and other financial metrics. By tracking business numbers, you can calculate the revenue you need to generate each day, at what time to have your sales, and whether you should implement a late invoice payment fee or not. The core financial metrics that every business owner should have knowledge of are cash flow, cash on hand, break-even point, and other metrics such as expenses, days to get paid, and so on.
How do I run my small business?
To start with, tracking your core financial metrics is a two-step process.
• Use accounting software instead of Word or Excel to track your numbers. This will prevent you from having to run a report each time you want to get an overview of the business. If your business involves sending invoices to clients, you can use Freshbooks. For businesses that are more complicated, you can use Quickbooks or Xero.
• Use a business management dashboard once you have gotten into the habit of tracking the important financial numbers of your business. Using a tool like LivePlan makes it easier to conduct the tracking process.
You might ask – what’s the difference between accounting software and a business management dashboard?
In a business management dashboard, you can obtain an overview of all aspects of your business immediately, whereas in accounting software, you have to run each report separately. Also, you can only compare numbers in accounting software. To get a graph, you will need to export the data to Excel.
Once you have mastered the tracking of your core financial metrics (and this can take between three and six months), you can take on additional metrics. You should be careful to choose the right metrics—those that bring the greatest value to your small business.
What are the metrics a small business owner should track?
As a business owner, the key financial metrics that you should be aware of include the following:
Profit Margin
Profit margin refers to the amount of money one earns per sale. This number matters in costs that are directly related to sales. It is not relevant in the case of utilities, rent, or office expenses, which are known as operating expenses or overhead.
Working Capital
Working capital refers to the amount by which the current assets of your business are greater than your current liabilities. This is different from the current ratio, which is expressed in the form of a percentage or decimal. Working capital is expressed as a dollar amount.
Sales Conversion
Sales conversion refers to the number of deals closed as compared to the number of opportunities found. It gives you an idea of how many people you need to talk to and how long you need to speak to them before you are able to turn a prospect into a sale.
Break even Point
Break even point refers to the point at which your business begins to make a profit. It is the stage at which the revenues generated are equal to the expenses sustained. This is an important metric because it helps you determine what your pricing should be in order to make profits.
Return on Equity
Return on equity is known as ROE in common parlance. It is an indicator of the amount of profit made by your business in comparison to the amount of equity invested.
Return on Investment
Return on investment or ROI is defined as a performance measure that is obtained by dividing net profit by net worth. It is the most commonly considered profitability ratio.
The hardest part is to start tracking your financial metrics on your own. However, once you get into the habit of doing it, you will not have to depend on an accountant to do your job for you. Neither will your business run into financial messes. Since the important decisions pertaining to your small business are made on the basis of the health of these metrics, it is essential that you begin tracking them early.