Here are three KPI’s that are important to understand when running a small business and managing its finances along with a brief description of each:
Measures the liquidity of your business. It will show you if your business can cover its immediate obligations. The current ratio is defined as the current assets of your business (most usually cash and accounts receivable) divided by the current liabilities of your business (vendor accounts payable, credit cards payable, short term balance on any loans, payroll liabilities). At a minimum you want this ratio to be 1:1 which indicates you have adequate current assets to meet your short-term liabilities. In an ideal world your current ratio would be 2:1 or better. This would indicate that you have double the current assets (cash and accounts receivable) to cover your current obligations. Building a cushion here shows that you can successfully build your business by turning your operations into much needed cash. Afterall, Cash is King!
Gross Profit Margin
Measures the percentage of revenue that is left over after deducting all expenses associated with creating and delivering your product or service for your customers. If your revenue is $5,000 and the cost to create, and deliver your product is $3,000 then your Gross Profit is $2,000 and your Gross Profit Margin is 40% ($2,000/$5,000). Your target Gross Margin will depend upon the type of business. Many software companies can have gross margins in excess of 60% while many labor-intensive service companies have Gross Margins from 35% – 55%. You want to make sure that regardless of your company that the Gross Profits you are generating are enough to cover the remaining operating expenses of your business. The higher the Gross Margin, generally the more profitable the organization. Many sophisticated companies understand the Gross Margins by individual product or service line. This will allow you to try and maximize the sale of the most profitable products and examine the less profitable products for potential improvements in production or delivery to enhance overall profits to the company.
Cash on Hand
Measures the amount of cash at a snapshot in time. This might seem obvious, however turning your company’s revenue and profits into cash, and growing the cash balance over time isn’t always easy. Once you have customers and a steady flow of revenue you need to establish a targeted cash balance that you can keep on hand. I am not talking about having just enough cash to cover your current needs like we talked about in the current ratio section, rather creating a goal of having 2-3 months of operating expenses on hand at any time. Most people want to talk about the revenue their business invoices or the profits that it generates. Converting your services or products into cash is the real measure of success. It is hard to spend revenue or profits, but it is easy to spend, or better yet, to save cash!
Let ChoiceFinance help you with understand the KPI’s and the financial strategy of your business and ultimately help you improve your profits and grow your cash!