In business, virtually every move you make has to be calculated. This is largely so because you are dealing with money. The need for laying down watertight plans is even more pronounced in a capitalist economy where the market is ever-changing. In addition, there is always a competitor looking to put you out of business for any mistake made. Unless you have risen to the level of Amazon, Microsoft, Google, and other such huge multinationals with little to no competition, you are never really out of the waters. You constantly need to be on your toes.
Even they, as large as they are, still pay attention to detail. What are these details? They are metrics. They are the things that, in a way, keep the business going by providing useful and actionable information. Without them, it is rather difficult to build/create a profitable business.
They span across various areas of a business, including the digital, financial, customer satisfaction, and software performance aspects, among others. In this article, we will be focusing on financial metrics that every profitable business follows. If you are a business owner, you should pay attention to these.
What are the financial metrics?
First off, a metric is a word that is used to refer to the measurement. Businesses use metrics to see if they are doing well and whether or not they are on track to achieving set goals. These metrics are useful for every part of business, including the accounting process.
As such, financial metrics are indicators of how well your business is performing financially. Among other things, it shows you where and when you need to switch things up or tone them down a little bit. The importance of the availability of this information cannot be overstated. This is largely so because they are often what stands between you and poor financial decisions that could really hurt your business.
What are the most common financial metrics that every profitable business follows?
Several things could point towards financial success or danger in business. They are particularly important. So much so that every profitable business in the world follows them. Here are six of those metrics:
1. The total cost of running the business
This metric is infinitely crucial to the success of the business. The total cost refers to the amount a company spends in keeping the business alive. It consists of two different aspects, which include the fixed and variable cost.
These two are basic-level accounting terminologies. Nevertheless, fixed cost refers to the amount of money you spend in business that does not change with the volume of production. It is relatively stable and much easier to budget. It includes anything and everything from rent to insurance and even office supplies.
Variable cost, on the other hand, is directly proportional to the volume of production. If you are making more products or offering more services, your variable cost increases. If you are producing less, your variable cost reduces. Considering that several factors could cause you to produce less, variable cost is more difficult to predict and budget. A few examples of it include labor costs, salaries, and staffing, material costs, etc.
This part is important to profitable businesses because it’s a marker for the profit margin. Talking of profits, keeping track of variable costs also helps you project how much profit your company can make within a certain period. Finally, businesses constantly look at this metric because it is important in attracting investors to the business.
This is another metric that no profitable business ignores. A company’s breakeven point refers to that point when revenue from sales finally equals the total outlay in terms of fixed and variable costs. Essentially, it shows that you are no longer at a loss, and, at least, you have made back the total initial investment in the business.
The area above a company’s breakeven point refers to the profit the company has made. That is the money gotten in a month, quarter, or year after making back the amount of money you spent keeping the business alive.
Paying attention to this metric in your business is particularly important. A proper breakeven analysis will help you with a couple of things. At the top of that list is that, with it, you can make a rough estimate of when your business will start making a profit, instead of running behind the line while your competition keeps gaining strategic advantages over you.
By paying attention to your breakeven point, you can see how much grace you have in terms of sales decline before you start running at a loss. It also helps you to get a rough estimate of the number of units you have to sell before you can make a decent profit. With this valuable information, you can then go ahead to make decisions that will help you make a profit at the earliest time possible in the year. Afterwards, you can then sit back, relax, “annualize” your profit with the run rate formula, and then maintain/intensify efforts to meet those projections.
3. Cash flow
This metric is observed by every profitable business to help them place the amount of money coming in vis-a-vis the amount going out. It is the heart and soul of every business because, without cash flow, a company simply cannot exist. In business, your cash flow can either be positive or negative.
Positive cash flow refers to when your company is making more money than it is spending within a specific fiscal period. Essentially, it refers to the profit. A negative cash flow, on the other hand, indicates that you are spending more than you are getting. In the same way that working more than you eat is not a healthy lifestyle, spending more than your revenue is bad for business.
By properly observing and analyzing their cash flow, a business can determine whether or not it is positive. Unfortunately, the results don’t always come out pretty. However, that is the entire reason behind observing the metric. It helps you determine when you need to take action that will help you shift the numbers in your favor. In the same vein, if your cash flow is positive, you can then choose to maintain the same efforts that got you there in the first place.
4. Customer acquisition cost and lifetime value
Customer acquisition cost (CAC) is the amount of money you expend into getting potential customers to purchase your service or product. For example, if you spend $500 on an advert and it gets you, 50 customers, your CAC is $500 divided by 50. This brings your CAC to $10.
Lifetime Value (LTV) refers to how much money you can get from one customer within the time that they purchase from your brand. If your service sets customers back by $150 every year and a customer remains loyal for three years, your LTV for that customer is $450.
Businesses pay attention to this metric because it is another indicator of how much money is being made and how much money they are spending. In addition, it helps them determine whether or not to begin making plans to scale the business. It is at this point that things get a bit critical. If a business does not calculate these numbers correctly and it chooses to scale before it should, it might end up spending too much, going bankrupt and closing shop all at once.
5. Net working capital
Some other people like to refer to this metric as working capital. Regardless of what it is called, it is what you get when you subtract your liabilities from your assets. It exists to assist in keeping track of a business’ short-term financial health.
Now, it is a tad challenging to avoid liabilities in a business. As such, there should be a balance. A relatively acceptable ratio of your assets to liabilities could be anything between 1.2 and 2.0.
If your ratio goes below 1.0, this means that you have less negative net working capital. This could lead to liquidity problems later on. If your assets to liabilities ratio are over 2.0, it could mean you’re underutilizing your assets. With this information, it is up to you to decide which course of action is the best.
6. Return on Investment (ROI)
A lot of spending you do in business is an investment. The whole point of it is to put in money in the present and then wait for the income expenses to generate profit. Marketing and advertising, in themselves, are also forms of investment.
This metric helps you to see if you made the right choice or not in investing in a certain part of a business. You can easily get this by subtracting your cost of investment from the profit you made from it. Afterwards, you’ll go ahead to divide your result by the cost of investment.
A good and profitable business pays very close attention to this metric. This is particularly because it is a strong indicator that informs continued investment or a complete pullout to prevent excessive loss of revenue.
Running a company is never easy. That’s why it is essential that you have a business mentor. For your company to be successful, several metrics require your attention. However, by properly observing the six we have listed above, you’ll be well on your way to running a profitable business.
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Founder Dinis Guarda
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