Every successful business monitors certain financial metrics that serve as a barometer for its financial health. These metrics assist in making informed business decisions, help predict future performance, and enable comparison with industry benchmarks. We delve into the top 10 financial metrics every business must track, complete with calculations and high-performing benchmarks.
1. Gross Profit Margin
Gross Profit Margin measures a company's efficiency in managing production and labor costs.
Calculation: If your business has a total revenue of £200,000 and the cost of goods sold (COGS) is £120,000, your Gross Profit is £80,000. The Gross Profit Margin is then (£80,000 / £200,000) * 100 = 40%.
Benchmark: A high performing business might target a gross profit margin above 50%.
2. Net Profit Margin
Net Profit Margin is the true reflection of your business's profitability, taking all costs into account, not just COGS. Net Profit = Total Revenue - Total Expenses (COGS + Indirect Costs).
Calculation: If your business has a net profit of £50,000 and a total revenue of £200,000, then your Net Profit Margin is (£50,000 / £200,000) * 100 = 25%.
Benchmark: A high net profit margin of 20% or more is often considered healthy in many industries.
3. Operating Cash Flow
Operating Cash Flow measures the cash a business generates from its core operations.
Calculation: Suppose your business has a net income of £50,000, depreciation of £10,000, and a £5,000 increase in working capital. Your Operating Cash Flow is £50,000 + £10,000 - £5,000 = £55,000.
Depreciation represents the wear and tear on assets over time. While it's an expense on the income statement, it's a non-cash charge, meaning no money actually leaves your business for depreciation. That's why it's added back when calculating the cash flow from operations. Working capital is the difference between a company's current assets (like cash, accounts receivable, and inventory) and current liabilities (like accounts payable). If working capital increases, it implies that more cash is tied up in assets like inventory or accounts receivable, or that accounts payable (money you owe to suppliers or vendors) have decreased. This would reduce your cash flow, which is why an increase in working capital is subtracted.
Benchmark: A positive operating cash flow is always a good sign. It indicates your business is self-sustaining.
4. Current Ratio
Current Ratio provides a snapshot of your business's short-term liquidity.
Calculation: If your business has current assets of £500,000 and current liabilities of £250,000, then your Current Ratio is £500,000 / £250,000 = 2.
Benchmark: A current ratio of 1.5 or above suggests that a business can comfortably cover its short-term liabilities.
5. Quick Ratio (Acid-Test Ratio)
Quick Ratio measures your business's ability to meet short-term obligations using its most liquid assets.
Calculation: If your business has £50,000 in cash, £20,000 in marketable securities i.e. stocks or bonds, £30,000 in accounts receivable, and £80,000 in current liabilities, then your Quick Ratio is (£50,000 + £20,000 + £30,000) / £80,000 = 1.25.
Benchmark: A quick ratio above 1 indicates a company is capable of paying off its immediate liabilities without selling inventory.
6. Debt-to-Equity Ratio
Debt-to-Equity Ratio is a measure of your business's financial leverage.
Calculation: If your business has total liabilities of £400,000 and shareholders' equity of £200,000, then your Debt-to-Equity Ratio is £400,000 / £200,000 = 2.
Benchmark: A ratio under 1 is typically considered good, signifying that a company's assets are financed more by equity than debt.
7. Return on Equity (ROE)
ROE shows how efficiently a company uses investment funds to generate profit.
Calculation: If your business has a net profit of £100,000 and average shareholders' equity of £500,000, then your ROE is £100,000 / £500,000 = 0.20, or 20%.
Benchmark: An ROE above 15% is often considered excellent in most industries.
8. Inventory Turnover Ratio
Inventory Turnover Ratio shows how often your company's inventory is sold and replaced.
Calculation: If your business has a COGS of £200,000 and an average inventory of £50,000, then your Inventory Turnover Ratio is £200,000 / £50,000 = 4.
Benchmark: A high ratio (say 6-8) signifies strong sales or effective inventory management.
9. Accounts Receivable Turnover Ratio
Accounts Receivable Turnover Ratio measures your business's efficiency in collecting its debts.
Calculation: If your business has net credit sales of £400,000 and an average accounts receivable of £50,000, then your Accounts Receivable Turnover Ratio is £400,000 / £50,000 = 8.
Benchmark: A high ratio (above 10, for example) indicates a fast collection process.
10. Earnings Before Interest, Taxes, Depreciation, and Amortization (EBITDA)
EBITDA shows a company's operational performance, eliminating effects of financing and accounting decisions.
Calculation: Suppose your business has a net income of £100,000, interest of £10,000, taxes of £20,000, depreciation of £15,000, and amortisation of £5,000. Your EBITDA would then be £100,000 + £10,000 + £20,000 + £15,000 + £5,000 = £150,000.
Benchmark: Higher EBITDA margins, such as 25-30%, can indicate stronger operational efficiency.
Each industry will have its own benchmarks, so it's essential to compare your metrics with businesses similar to yours. Regular monitoring and understanding of these metrics can offer crucial insights into your business's financial health and inform strategic decision-making.