With automated accounting software like Xero you need to invest less and less time into staying on top of your bookwork. That means more time to focus on running your business. Just don’t forget that a big part of running your business is managing your finances.
We recommend that you create a dashboard of key financial measures and review your progress against these measures at least monthly. This gives you a chance to identify things that may be going sideways and take steps to get finances back on track.
We summarise here five key metrics that will help you monitor your financial progress.
This ratio shows the average number of days it takes for your business to receive payment from your debtors. The higher the number of days, the more of your cash is tied up in accounts receivable and not available to pay your bills. If your debtor days is trending well outside your trading terms we recommend you make debt collection a major focus.
(Accounts receivable / Annual revenue) x 365 days
Quick Ratio or Current Ratio
The quick ratio compares your current or short-term assets (things like cash, bank accounts, accounts receivable and inventory) against your current or short-term liabilities (things like accounts payable, short term loans).
The Quick Ratio shows how well your short-term operations are funding the overall cost of doing business. When your Quick Ratio gets smaller it means you are incurring more debt to finance operations. It is quite natural for this ratio to move up and down, but a continuing downward trend could spell trouble.
Current assets / current liabilities
Your operating margin measures income from operations divided by your net sales. This represents your profits after deducting the variable costs of production or service delivery. A ratio of one means there is no cost to doing business and all your income from sales contributes to profit. The lower the ratio the more of your income is being eaten up in production or service delivery.
Your target operating-margin will vary depending on your industry. It’s a good idea to consider industry benchmarks when evaluating your operating margin.
Operating Income / Net Sales
This ratio is particularly useful for any business trading in physical stock. Basically it measures how often your business inventory is sold and replaced in a particular period.
The lower your inventory turnover the more of your money is tied up in stock, which hurts your cash flow. Conversely if your inventory turnover is too high this could indicate that you don’t have sufficient stock available.
This is another measure that will vary considerably depending upon your industry. We suggest you consider industry benchmarks when assessing your industry turnover results.
Annual cost of goods sold / Average inventory
Return on Owner’s Equity
This ratio reveals how much you are making on the money you’ve invested in your business. It’s useful to compare this number with what you might be earning if your funds were invested in other ways.
Net income / Owner’s Equity
If you would like help setting up a financial dashboard for your business please contact us.