The key financial ratios to keep an eye on to grow your business
If you use controlling software like CoPlanner, you probably have access to a large amount of financial reports that give you insight into your company's performance. However, if you're like most busy entrepreneurs in the service, retail, industrial or public sectors, you don't have the time, inclination or strategic know-how to analyze and understand in minute detail the many complex numbers that reflect their company's current financial position. In fact, many entrepreneurs focus only on what they care about and skim the big picture. But no matter how talented and dedicated you are to your craft, product or service, if you don't take care of the financial side of your business, it's quickly doomed to fail.
So what, specifically, should you do? Let's look at the seven items you need to review monthly to optimize your profits and keep them there. Don't worry, you don't have to be a certified public accountant to understand how to interpret their numbers and derive them from key financial reports. Controlling software will help you create these corporate reports (reports) properly and legibly.
Once you have a holistic view of their financial reports that measure the financial health of your business, you can better make forward-looking and strategic decisions for the future.
Profit and loss account
You've probably heard the expression, "What's the bottom line?" It comes directly from the income statement (P&L), also known as a company's profit and loss statement. The "bottom line" is the last line of an income statement - the number that indicates whether a company made a profit (+) or a loss (-).
Profit (also called "net income" or "net profit") indicates how much money you have earned in an accounting period after deducting expenses. It is most helpful to analyze your P&L regularly (i.e., at least once a month) so that you:
- monitor expenses and look for ways to reduce your expenses so that your profit increases
- Identify at what times of the year you tend to have less work and make less money so you know when to cut back or increase your sales efforts
- Show trends on your revenues - are they increasing or decreasing? Do you need to increase your revenue through sales and marketing, or do you need to charge more for your products and services?
Ultimately, if your business is not profitable or not making enough profit, it is not sustainable. As a business owner, focus on the "bottom line" of your profit and loss statement to ensure you are making the money you need.
Running a successful business often requires investing in things like equipment, office supplies, travel, training, advertising and other operating costs. Depending on the type of business you run, these expenses can quickly increase and even exceed your revenue, so it's important to regularly enter and update your ongoing operating expenses in your controlling software and review these numbers monthly. If you take this time and the costs are included in your profit and loss statement, it will be clear whether you are making or losing money.
The controlling software also has a cost breakdown that shows you in which categories you spend. By reviewing your spending patterns, you can decide where to make targeted savings if needed. Your only job in monitoring expenses is to make sure they don't grow faster than your income. The exception would be if you have an intended long-term investment to make, such as hiring new employees or buying new equipment/machinery that will pay for itself over time.
Have you ever wished you could shake a tree and money would fall out? Accounts receivable, come very close to that.
Accounts receivable is really just a fancy euphemism for "money owed to me." It's the total of your unpaid invoices that appears as a line on your balance sheet, another basic financial report. If your accounts receivable are a large number, you have a lot of money in the till.
If you're experiencing cash flow difficulties, take a look at the "Accounts Receivable" line item on your company's balance sheet. Late or unpaid invoices are often the cause of financial distress for entrepreneurs. That's why it pays (literally) to make sure your customers pay on time and your cash flow doesn't stall. Controlling software offers automatic payment reminders and other features to help you stay on top of things.
If you know what your outgoing figures are at any given time, you can better decide what to invest in, when and how.
Profit by customer
Not all customers are the same. Financially, some are much more lucrative than others. Favorite clients aren't the ones who pay the highest fees - they're the ones who generate the most profit.
It can be pretty exciting to land a big-name client, but often you'll have to invest in additional equipment, insurance, travel and other expenses to do so. Even though these clients pay more, they often come at a higher cost. In contrast, some of your smaller clients may not pay as much, but their projects add up to a higher profit.
Good controlling software will provide you with a report on revenue by client here. This financial report can give you an overview to see exactly what each client is "worth" to your business, but it's also helpful to take an extra step to determine how much profit it generates. To calculate this, take the total fees you received from a client and subtract any costs associated with working for the client. This is your gross profit. When you record the hours spent working with the client, divide that net profit by the approximate number of hours you spend working for the client. This is your "hourly wage" for that customer.
Compare this wage between different clients to determine which ones are most lucrative for you. Focus your marketing on getting more clients that are lucrative, even if they are not the "biggest" projects. This way you'll make the most money with the least amount of time.
One of the most difficult concepts for businesses to understand is cash flow. It refers to the actual money that flows in (revenue) and out (expenses) of your business over a given period of time. Your cash flow statement shows how much money is available at the end of that period.
Even if your income statement shows a steady profit, you may have a cash flow problem. Maybe you've invoiced for a big project, but the payment period is 60 or 90 days, so you won't have any money available for a while. In the meantime, your expenses may be reasonable relative to your income, but if a large investment in, say, equipment is needed while you're waiting for the money to come in, you won't end up with enough to pay for it.
Controlling experts advise reviewing your cash flow statements regularly so you can properly time your purchases and ensure your customers pay promptly.
Would you like to know, for example, how much money you earn with each item sold and how often you actually sell this item? The controlling software offers this insight through a so-called item sales report.
This is important because it shows you the activity for each of your products or services. Depending on how you have your software set up, you can even see how much profit you are making on each item. You can also check how discounts on certain products affect their profitability. Such usage provides important information that will let you decide which items you should dedicate the most time and attention to and which ones you shouldn't.
Wondering how profitable entire projects are for your business? Use a project profitability report. Several controlling software offer a project profitability reporting tool that tracks the performance of your projects to see how profitable your operational activities are, which can be especially helpful if you have multiple people working on them. It takes into account the time and expenses your team members have spent on projects, helping you make better project management decisions in the short term and better business decisions in the long term.
When it comes to financials, the old adage "those who fail to plan, plan to fail" sums up everything you need to know. Like it or not, numbers say a lot about a business's financial performance. They can tell a business owner things like:
- what kind of customers (customer segmentation) to target to make the most profit
- How much to earn from a project or product to make it profitable
- what kind of investments make sense and are affordable and should be made in the end
- which customers are in arrears
- what kind of profit you can expect based on past performance
- Cash flow in real time
These are important accounting principles that guide decision-making for both large and small businesses. Controlling experts recommend reading financial statements on the first day of each month, starting with the cash flow statement. That way, you can adjust your business strategy as needed. And once you get in the habit of analyzing the data on a regular basis, you may find additional reports that can help you measure your company's success even more effectively.
In the long run, it will pay off positively to scrutinize your numbers regularly.