As a business owner you need to know how to measure the performance of your business. One thing’s for sure when it comes to business: it’s unpredictable. That’s why you need to be constantly measuring your business performance across multiple metrics to know what works and what doesn’t work, be able to predict upcoming changes, and be prepared for unforeseen circumstances.
While it’s crucial to measure customer satisfaction, employee engagement, and even assess your own happiness as a business owner to track the success of your business, it’s just as important to measure the financial side of your business.
That’s why in this post we go over how to properly conduct a financial performance review for your business.
Review Your Business’ Financial Statements
To see how profitable your business is and know your financial position, the first step is to look into your financial statements. Three important financial statements to review are the income statement, balance sheet, and cash flow statement.
An income statement shows revenues and expenses during a particular period. Income statements help business owners decide whether they should be increasing revenues, decreasing costs, or do both in order to generate profit.
A balance sheet reports a business’ current assets, liabilities, and shareholder equity. Balance sheets help to assess a company’s capital structure and provide the foundation for computing rates of return for investors. In other words, balance sheets provide an overview of what an enterprise owns and owes, and what amounts shareholders have invested.
The cash flow statement outlines the movement of cash inflows and outflows of a business. In general, business cash flow is crucial because it allows business owners to cover short-term debt, gives them more negotiating power, and lets them seize new opportunities. The cash flow statement evaluates how well a business manages its cash position (to what extent the company can pay its debt and fund operating expenses).
Calculate Your Financial Ratios
Another way to evaluate your company’s financial health is by measuring financial ratios, which measures the relationship among multiple factors from financial statements. This financial analysis will help the management team observe the business’ performance over time, and narrow in on strengths and weaknesses, which they can use to build strategies and initiatives.
One ratio to analyze is profitability sustainability ratios which can show you how well your business is performing over a specific period of time. Sales growth, which is the percentage (increase or decrease) in sales between two time frames, falls under this type of ratio. For example, you’ll want to reevaluate your pricing strategy to reflect inflation.
Gross profit margin also falls under profitability sustainability ratio. This illustrates how much profit is earned on your products (not including indirect costs).
Liquidity ratios reflect whether you have enough cash flow and can meet operational obligations. This is important for your business’ financial health, because if you suddenly lack liquidity, you will have difficulty paying debts and sustaining production. Current ratios are a type of liquidity ratio and measure your capacity to meet short-term commitments with short term assets. Current ratios are a great way to forecast your cash flow.
Business performance can also be measured by operational efficiency ratios, which demonstrate how efficiently you’re making use of your current assets and managing liabilities (e.g. bonds, warranties, mortgages, and deferred revenues). One such ratio is the operating expense ratio, which compares expenses to revenue. In this case you want a decreasing ratio because it indicates increased efficiency.
Calculating financial ratios is just one aspect of financial analysis to determine your business’ financial position, showing you how well it’s performing, forecasting cash flow, and demonstrating operational efficiency.
Measure Business Processes
The efficacy of your business and how smoothly the management systems run ties directly into the financial success of your business. That’s why you’ll want to measure how smooth your business procedures are and make necessary adjustments and informed decisions from there.
One metric to look at is the current accounts receivable ratio, which reflects the extent to which customers pay invoices when they’re due (money owed to a business by its debtors). This metric helps to plan cashflow and estimates upcoming revenue more precisely. A higher ratio in this case means fewer overdue invoices, while a lower ratio indicates more past-due invoices.
Speaking of invoices, another metric to measure business efficiency is average invoice processing cost, which approximates the average cost of bills paid to suppliers. These costs include bank charges, systems, overhead, etc. Overall processing cost can be influenced by outsourcing and the level of accounts payable (AP) automation (this is technology that can expedite back-end processes). A lower cost means a more efficient AP process.
This is where accounting software comes into play. Accounting software can help you to not only track accounts receivable and average income-processing costs but also make these processes more efficient. For example, with accounting software you can send recurring invoices and overdue notifications automatically, which will not only save you time and money but also boost business success.
Investigate Your Business’ Market Position
Some aspects of your business performance are beyond your control. For instance, maybe there’s less demand for your product, or there’s a lull in the market. That’s why you need to know the current landscape of the market. One way to do this is to conduct a competitor analysis, to know how your competitors are doing and how you stack up against them.
Decreased profitability could be a good time to introduce new products (especially if the demand for your current offerings are low) or even revamp old products. Streamlining what you offer will help you to feel more focused, decrease production costs, and give you a competitive advantage.
Another part of market research will also entail gathering customer feedback — what are they looking for? What problem are you solving for them? Insights from your customers will not only help you improve your products but also your customer service — since they’re the ones that drive the sales.
Now more than ever, business owners not only need to not only stay on top of their finances on a regular basis, but also conduct a financial review (whether it’s monthly, quarterly or yearly) to create business strategies and determine business success.
There are many components to consider when performing a financial analysis including financial statements (income statement, balance sheet, and cash flow statement), financial ratios, investigating business processes (to eliminate business inefficiencies), and determining where your business stands in comparison to your closest competitors.
With all of this information you can see what your business’ financial position is and where you can improve. Financial metrics are crucial, but only if you know how to measure them and utilize them to your advantage.
If you need advice on how cloud accounting can help your business with financial management and give you a clearer idea of your business’ financial position, you can request a free consultation right here from one of our London Chartered Accountants. Knowing where your business stands will help you make necessary business decisions and give you peace of mind.