As a business owner, you know how important it is to keep track of your financial performance. But with so many numbers and reports to look at, it can be difficult to know which ones are the most relevant and useful for your business, and complicated to understand their impact.
Here we have compiled a list of a few key finance metrics that every business should monitor and understand. These metrics will help you measure your profitability, liquidity, solvency and efficiency, help you to run a regular SWOT analysis to give you insights into your strengths, weaknesses, opportunities, and threats.
- Net Profit Margin
Net profit margin is the percentage of revenue that you keep as profit after deducting all your expenses. It shows how well you manage your costs and how profitable your business is.
To calculate your net profit margin, you need to know your net profit and your revenue. Net profit is the difference between your total revenue and your total expenses. Revenue is the amount of money you earn from selling your products or services.
A higher net profit margin indicates that your business is more efficient and profitable. A lower net profit margin indicates that your business is less efficient and profitable, or that your expenses are too high.
You should compare your net profit margin with your industry average and your competitors to see how you stack up. You should also track your net profit margin over time to see if it is improving or declining.
- Current Ratio
Current ratio is the ratio of your current assets to your current liabilities. It shows how well you can pay your short-term debts and obligations with your short-term resources.
To calculate your current ratio, you need to know your current assets and your current liabilities. Current assets are the assets that you can easily convert into cash within a year, such as cash, accounts receivable, inventory, and prepaid expenses. Current liabilities are the liabilities that you have to pay within a year, such as accounts payable, accrued expenses, short-term loans, and taxes.
A higher current ratio indicates that your business is more liquid and can easily pay its short-term debts. A lower current ratio indicates that your business is less liquid and may struggle to pay its short-term debts.
A general rule of thumb is that your current ratio should be at least 1. This means that you have enough current assets to cover your current liabilities. However, the ideal current ratio may vary depending on your industry and business model.
You should compare your current ratio with your industry average and your competitors to see how you rank. You should also track your current ratio over time to see if it is increasing or decreasing.
- Debt-to-Equity Ratio
Debt-to-equity ratio is the ratio of your total debt to your total equity. It shows how much you rely on debt to finance your business and how much you owe to your creditors compared to your shareholders.
To calculate your debt-to-equity ratio, you need to know your total debt and your total equity. Total debt is the sum of your current and long-term liabilities, such as loans, bonds, leases, and mortgages. Total equity is the difference between your total assets and your total liabilities, or the amount of money that belongs to you and your shareholders.
A higher debt-to-equity ratio indicates that your business is more leveraged and risky, as you have more obligations to your creditors. A lower debt-to-equity ratio indicates that your business is less leveraged and risky, as you have more ownership and control over your assets.
There is no universal standard for the optimal debt-to-equity ratio, as it depends on your industry, growth stage, and financial strategy. However, a general rule of thumb is that your debt-to-equity ratio should not exceed 2. This means that you should not have more than twice as much debt as equity.
You should compare your debt-to-equity ratio with your industry average and your competitors to see how you fare. You should also track your debt-to-equity ratio over time to see if it is rising or falling.
- Inventory Turnover Ratio
Inventory turnover ratio is the ratio of your cost of goods sold to your average inventory. It shows how efficiently you manage your inventory and how quickly you sell your products.
To calculate your inventory turnover ratio, you need to know your cost of goods sold and your average inventory. Cost of goods sold is the cost of producing or purchasing the goods that you sell, such as materials, labor, and overhead. Average inventory is the average value of your inventory during a period, usually a year or a quarter.
A higher inventory turnover ratio indicates that your business is more efficient and profitable, as you have less inventory holding costs and more sales. A lower inventory turnover ratio indicates that your business is less efficient and profitable, as you have more inventory holding costs and less sales.
You should compare your inventory turnover ratio with your industry average and your competitors to see how you perform. You should also track your inventory turnover ratio over time to see if it is improving or deteriorating.
A qualified accountant can help you to calculate and understand these metrics for your business to enhance your growth potential.