According to the Bureau of Labor StatisticsOpens a new window , around 20 percent of small businesses fail in the first year. And, somewhat shockingly, half fail by year five. In most cases, this failure isn’t related to the business concept or the determination of the individuals behind the venture. The most common cause of failure is financial mismanagement. Unless managers are on top of a business’ finances from day one, they run the risk of losing control.
With this in mind, there are a few key financial analyticsOpens a new window that need to be monitored on an ongoing basis — and here are five of the most important.
1. Cash Flow
In the most simple of terms, cash flow is a general view of the economic health of a business. It’s far more complex than the cash businesses have at any given moment, but that does play a role.
In most cases, cash flowOpens a new window is calculated by subtracting liabilities (money going out) from the money a business generates. But accurate calculations are a lot more complex than that. The calculation also includes depreciation, and takes into account inventory and money owed. When the cash coming into the business exceeds the cash going out, the outlook is positive. When the reverse is true, however, it’s only a matter of time before the cash runs out.
A financial management software package can calculate cash flow with relative ease, but it’s only ever as reliable as the data provided.
2. Net Income
Net income is directly linked to cash flow, and every bit as important. Topline income is the money that comes into a business periodically. While this is important, it never tells the full story. After all, a firm could be recording record sales; but if the cost of achieving those sales is high, they won’t convert to a healthy profit.
In simple terms, net income is calculated by subtracting all of the costs of doing business (including paying tax) from the business’ income.
3. Gross Margin
Often referred to as gross profit or the “bottom line,†gross margin tells you how profitable a business is. Stated simply, gross margin is the difference between the cost of something and how much you sell it for.
For example, for a company making burgers, the gross margin is the price the diner pays less the cost of the ingredients. It’s important to ensure that this margin is in line with industry averages, and that it’s sufficient to cover all the other expenses, such as labor and electricity.
4. Sales Forecasts
Sales directly impact on the overall profitability of a business, and its ability to cover its fixed costs. A business set up for long-term success usually forecasts future sales in order to plan for a range of eventualities, including labor, marketing budgets and stock-holdings.
There are lots of ways to predict sales, including the use of historical data, analysing market trends and various external factors such as the weather or the economy. Compiling accurate forecasts is essential, as it allows businesses to cut their costs or scale up as necessary.
5. Customer Profitability
Every small business should know where its margin comes from. And in most cases, this isn’t always immediately obvious. If a business is selling various lines at many different price points, some products or services will be more profitable than others. As a result, the minority of an organization’s customers could be responsible for the vast majority of its profits.
Understanding which customer groups contribute the most amount of profit is essential. For example, if middle-aged men tend to buy the high-margin products in a business, devoting a significant chunk of a marketing budget to that demographic is probably a good idea.
Thankfully, small businesses don’t need a team of crack accountants or finance experts to identify and monitor key financial analytics. With a little knowledge and the right software package, keeping your business on the road to financial health shouldn’t be too challenging.