The 9 Most Important Financial Numbers ExplainedWritten by Bernard on December 05, 2016
It’s not an understatement that small business owners carry a lot of weight on their shoulders. From having to take care of sales and marketing, production, customer service, and overall bill-payer, small business owners have a lot to do.
Unfortunately for most, that also includes the accounting, finances, and often complicated financial numbers.
Sometimes it all can seem quite overwhelming, and small business owners find themselves drowning in just too much work. This usually leads to some sort of burnout, but it doesn’t have to, not with the right knowledge.
So to help out small business owners who need a bit more finance training, we’re going to explain the 9 most important financial numbers you need to run your business successfully.
It’s number one for a reason. Operating cash flow is the lifeblood of your business and therefore needs to have all your focus trained on that. It often doesn’t matter what your revenue is if you don’t have positive cash flow. That is mainly because you won’t be able to pay your bills, your employees, or yourself, and soon you will have to close your doors for good. To calculate cash flow:
Cash inflow – cash outflow = cash flow
If it’s positive, and you have more inflow (money from goods and services) than outflow (bills, loan payments, taxes, etc.), your business is doing fine.
Also known as net profit or net earnings, your net income is quite related to your cash flow. This is a good indicator of how your business is doing, whether there needs to be an adjustment, or if you are on the right path.
You can calculate your net income easily:
Your overall income – expenses (including taxes) = net income
Knowing this number will help you determine the financial position of your business.
Profit and Loss
As we’ve mentioned before, your Profit & Loss (P&L or income) statement is crucial, as it gives you a snapshot of the financial status of your business. You create your P&L statement on a weekly, monthly, quarterly, or yearly basis, although most often it is done quarterly, semi-annually or annually. To calculate your profit and loss:
Your company’s revenue – your company’s expenses = profit or loss
If it’s positive, your company has made a profit, and the opposite is a loss.
Cost of Revenue
Although there is such a thing as Cost of Goods Sold (COGS), we can only truly use that for businesses that sell physical products and have inventories. Here, we’ll need to calculate the cost of revenue per unit of good or service. This will help you determine what your hourly rate should be for your services by calculating how much it actually costs for you to produce that service or product.
To calculate your Cost of Revenue:
Raw Materials + Direct Labor + Shipping/Transportation Costs + Sales Commission = Cost of Revenue
For example, I have a landscaping business and I need to do general upkeep on large home, so I will calculate the Cost of Revenue per hour. To make it simple, I won’t really have raw materials (that’s for physical goods). However, I will have direct labor of 3 people x $10/hr for 6 hours. My transportation costs will be $150 for a 200-mile round-trip with 2 cars. For sales commission, I will pay my sales rep 10% on this $1200 job, which is $120. Now I have:
0 (Raw materials) + $30/hr + $25/hr (dividing $150/6 hours) + $20 (dividing $120 commission/6 hours) = $75
In order to do landscaping on this job, it will cost me $75/hr. I will need to make sure I charge much more than that in order to have a successful business.
Your gross margin, also known as the gross profit, is in a way related to your cost of revenue. It determines how much money is actually left over after you’ve subtracted the cost of your merchandise or services. It is calculated:
Sales price – Cost to produce good or service = Gross Margin
If you are in a competitive market, your margin will be quite low; however, if you have proprietary goods or high quality, in-demand services, your margin will be high.
For those small businesses with physical goods, it’s crucial that you measure how much inventory you have on a weekly basis to make sure that it isn’t increasing. If your inventory is increasing, this is usually an indicator of sales problems. You will need to adjust your orders or productions in order to balance out the decreased sales.
Connected to your inventory, remember, are storage costs, waste, and of course reduced profits, so it’s very important that you monitor your inventory number.
Days Sales Outstanding
This is important for any business, and it is the number of days on average that it takes a customer to pay his or her invoice. If this number is small, that’s great, as that is a sign of positive cash flow. The company can then use that to reinvest into the company. The number should be less than 133% of the agreed upon payment terms. Mathematically:
payment terms * 133% > Days sales outstanding
Therefore, if you set payment terms at 30 days, the DSO has to be 40 days or less. If it is more, you should follow one of our many tips on how to decrease payment time on invoices.
The Quick Ratio
This is a very quick measure that you get from your balance sheet about the financial stability of your business. Remember, for a balance sheet, the assets (cash, accounts receivables, cash equivalents) minus liabilities (taxes, accounts payable, long-term debt) equals the equity. For the quick ratio:
Business current assets / business current liabilities = quick ratio
Optimally, the ratio should be greater than 1. If not, you’ll need to improve your company’s profitability.
Your 20% customers
Lastly, we have a number that is less generally calculable than the ones before. This is more a tracking of your very best customers, and it is based on the Pareto principle (also known as the 80/20 principle).
Your most important customers are valuable for the simple fact that 20% of your customers contribute to 80% of your revenue (and 20% of that 20% contributes to 80% revenue of that 80%, ad infinitum). If you know who your 20% customers are (or more easily, your top 10) you can work to get more sales out of them, as well as find out how to convert other customers into your top customers.
The most important financial numbers
Knowing these financial numbers will help you to create a stable, strong, and profitable business, and the math really isn’t that involved. All you need is a determination to understand your business and improve it as much as possible