Running a growing business is not easy, your eyes and ears need to be everywhere – from the quality of coffee served to your employees, to the next round of funding you need. In the midst of all this, it is possible that you may miss vital cues about the financial health of your business. Monthly MIS reports can be extensive, time-consuming, and difficult to understand. Also, they just report historic performance without giving you any idea what you should do to take your business forward.
This article is to help you focus on the numbers that matter, numbers that can give you a pulse of your organization’s financial performance in a nutshell. Keeping an eye on these key financial metrics can also alert you to any red flags that should be attended to, ASAP.
Fundamental Financial Metrics
These are the obvious ones that any founder would look at regularly. There is no need to state that these are important, and that you should never take your eyes off them.
Total income generated from the sale of services or products before deducting any expenses. The Revenue number will help you to understand if your sales and market share are growing, though it does not reflect your profitability. Revenue numbers could be further divided by quarter, by month, by geography, by products, by business, or any dimension that matters to you.
EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization)
Total income generated by your business after deducting operating expenses. This is a measure of your business’s operations and profitability without including interest, taxes, depreciation, and amortization. EBITDA is used by investors and stakeholders to compare the performance of organizations within the same industry.
Also known as the bottom line, this is a true indicator of your profitability since it gives you the company’s profit after deducting all expenses, including taxes and interest. Profitability is what determines if you have enough money to run your operations well, as well as invest some money in growth.
Operating expenses are costs incurred in running the day-to-day operations of a business, such as salaries, rent, utilities, and marketing expenses. This number should be monitored to check for areas of cost optimization and process improvements.
This is a measure of the % of revenue that comes in after deducting the direct costs involved in offering that product or service.
(Revenue – Direct costs)/ Revenue * 100
Higher the gross margin, better your profitability. As you can see from the formula, you can improve Gross margin by increasing your revenue or by reducing the direct costs.
Deep-dive into metrics that matter
In addition to the fundamental metrics, there are a few other numbers that matter to your business. Some of these might be part of your regular MIS and some might not. This list will help you zero in on the numbers that matter, instead of looking at a sea of numbers each month, clouding your vision and focus.
Most of these numbers will influence how your Net Income increases or decreases to a large extent. While looking at your Income and profitability, you should also know what to tweak so that your Net Income increases; and these numbers will give you the answer.
Accounts Receivable (AR)
Accounts Receivable refers to the money owed to your business by the customers for services or products that are already delivered. These numbers can be quite high in India, where delayed invoice payments and credit period extensions are very common. Monitoring AR numbers can help you manage cash flow and minimize bad debts.
Accounts Payable (AP)
Accounts Payable is the money owed by your business to the vendors or suppliers for services or products that you have already obtained from them. Ensuring that your AP numbers are good will keep your vendors happy, and also give you a good sense of your Net Income after paying all outstanding balances.
Break-even sales is a number that not many founders look at. It is the state where the revenue you make is equal to the cost you incur, therefore resulting in zero profit or loss. Though this is not the ideal situation to be in, a new business will move from loss towards profit after you achieve this important milestone of breakeven sales. CEOs should closely monitor break-even sales to understand the financial health of your business.
Product or Service Contribution to Sales
Just as you split revenue by products, geographies, or business units, it is prudent to split sales also by products, services, geographies, business units, or categories to help you understand what is doing well. This will help you focus on products or services that matter, either culling out, or repositioning products and services that aren’t working. These numbers can also help you allocate resources effectively for maximum productivity and profitability.
Monthly Salary Costs
A number that is easily available to founders and CEOs, this represents the total salaries and wages paid to employees or contract workers. When profitability decreases, and you have to cut down on costs drastically, most businesses look at layoffs as an option to save money. Having your monthly salary costs aligned with budgets will help you stay on track concerning expenses.
Movement of cash in and out of your business is a good measure of your liquidity and operational stability. A positive cash flow ensures that you have enough money to run your business, and to invest some for the future. Whereas a negative cash flow indicates distress which could result in cost-cutting measures. CEOs and founders should keep an eye on the cash flow to make sure that there is enough liquidity.
Unit economics involves direct expenses and revenues for one single unit of product or service. It deals with the profitability of the smallest unit sold, thus giving a better understanding of your profitability and sustainability.
This is calculated by subtracting the Cost Incurred in producing one unit from the Price per unit. The cost incurred by a unit is tricky to calculate since you have to decide what costs would be included in this formula. Read more about Unit Economics and how to calculate it here.
Customer Acquisition Cost
Customer Acquisition Cost is calculated by dividing the total cost incurred in acquiring new customers by the number of new customers during a certain time period. The cost incurred in acquiring new customers typically involves sales and marketing costs like salaries, campaign costs, software costs, and overheads.
Return on Investment (ROI)
Return on Investment denotes the profitability of any investment compared to its cost. This can be measured for sales and marketing initiatives, product launches, new geography expansions, and so on, to help you understand how a particular initiative or business division is contributing to the company’s profitability.
Know your business better through Financial metrics
As a business owner, you are surrounded by numbers and reports from MIS tools, business units, finance team, competitor metrics, market trends, and so on. It is important to look at numbers that truly matter to your business, without getting distracted by everything around you.
When you are starting your business, you cannot focus on profitability during the initial days. Build your business, get the word around, and get enough volume of business before you start to worry about breaking even, and being profitable. The market is rife with funding opportunities, and also with competitors. So, a founder has to be prudent in getting the right investments at the right time to make the best use of market opportunities.
At Finavi, we take pride in guiding many small and emerging businesses from incorporation to growth and profitability. Reach out to us if you need help in collecting and monitoring the right financial metrics. Our financial analytics tool, CANVAS can help your financial planning by making data available in real time with easy-to-understand dashboards and reports.