What are the critical numbers you should be keeping close tabs on in your business? It depends who you ask, but there are a few most can agree on.
The trouble is, when it comes to the numbers, far too many business owners either gloss over them leaving it to the accountant to track, or give too much merit to the wrong figures. Of course, having a reliable and savvy CPA is imperative, but the financial health of the company ultimately is the responsibility of business leaders.
With that in mind, what numbers should you be monitoring, and understand intimately, to ensure your business maintains, and continually improves, its health --financially speaking? It will depend on your goals and your business, but here are a few that will give you good insight into the financial vitality of your business.
Profit vs. revenue
Too often revenue gets all the glory. We hear it thrown around all too often: "What are your revenues like?," "Revenues are up this quarter," or "We hit record-breaking revenues this year." But how profitable was the business?
Revenues are important and a good starting point on the profit and loss (P&L) statement, but if you're not paying close attention to the direct costs, you're not getting a true picture of your business's financial health. Your profits represent the difference between what your business earned and what it spent, and it can be one key indicator of financial health.
Well known CPA and author, Greg Crabtree, reported the following findings in his book, "Simple Numbers, Straight Talk, Big Profits," based research his firm conducted:
- At 5 percent pretax profit, your business is on life support
- At 10 percent pretax profit, the business is doing well, but has untapped potential
- At 15 percent pretax profit, the business is in great shape
- Anything above 15 percent --earn it while you can, it may not last over the long haul
While profitability may seem straightforward, there are several figures --net income, gross margin, and EBITDA (earnings before interest, taxes, depreciation, and amortization) -- that can indicate profitability. And while profitability is critical, it's important to keep in mind that while your company may be turning a profit, it could be failing to keep money in the bank. Thus, drilling down a little further will give you a more clear picture.
In fact, there's an old phrase, "Revenue is vanity, profit is sanity, and cash flow is king." Let's look at a few numbers that, if managed properly can help you achieve or maintain a positive cash flow.
Gross margin is also commonly referred to as gross profit. This is revenue minus all direct costs, not including direct labor cost. Direct costs, or cost of good sold, include things like subcontractor costs, material costs, merchandise costs.
Insight into this figure allows you to see which expenses are most severely impacting your bottom line. This number doesn't, however, include labor costs since that is considered a key driver of profitability and will be accounted for in the operating expenses.
Gross margin represents the money you have left after your direct costs to pay your indirect or overhead costs, and still make money. And it may go without saying, but the higher your margin the better.
Direct labor costs and operating costs
Calculating your direct labor costs separately from your direct costs allows you to gauge your labor efficiency, giving you leverage to see where you might be able to improve your productivity per dollar spent on labor.
Arriving at this figure is simple -- it's your gross margin or gross profit minus direct labor. This number is often referred to as contribution margin, and it shows the true output of your business engine before any operating costs.
Operating costs need little explanation, they are simply the costs associated with resources (marketing, rent, employee benefits, repairs, travel, etc.) used by your organization to maintain its existence. Knowing your operating costs better allows you to plan for the unknown.
Core capital and cash flow
Having a handle on what your operating expenses gives you clarity into how much you'll need to have in reserves, or what some call your core capital. Most businesses will want to maintain at least two months of core capital in their reserves to weather slow times or downturns.
If you're Microsoft, you'll have a year's worth of operating expenses in the bank. This was something Bill Gates mandated from the beginning. It's up to you to decide on the amount of core capital that will make you comfortable, and based on your cash flow, you'll be able to see how long it will take you to build up that reserve if you're not already there.
Cash flow is another important number to know as it represents cold, hard, factual numbers. These are numbers, unlike profit, in which the data cannot be manipulated and they are often used to determine performance.
Broadly speaking, cash flow refers to your business's availability of cash. But from an outside perspective --a banker, potential buyer, partner, investor --it also paints a picture of the management competency.
Of course there are other numbers you'll want to measure that aren't typical CPA metrics, like operating and sales metrics, but these do influence the bottom line. These include, marketing qualified leads (MQLs), sales qualified leads (SQLs), turnover or churn rate, average dollar per employee, and utilization rates versus realization rates.
Managing these figures may seem like the last thing you want to do on top of everything else you oversee in the business, but they represent the lifeblood of the company. The good news is, you don't need an accounting degree or be a mathematician to arrive at these figures. The most important thing is determining what your key performance indicators (KPIs) are then creating a consistent way of measuring and checking up on them.