3 Critical Financial Ratios Small Business Owners Should Follow
There are four ways to increase income and two to increase profits. You can increase revenue by increasing the number of transactions per customer, increasing the average sale, increasing the number of customers, and increasing prices. You can increase profits by reducing costs and / or increasing prices. Remember that your income is the total of all the money you come in and your earnings are what is left after all expenses and taxes.
Most small business owners have an accountant or at least use accounting software that can provide financial statements, balance sheets, etc. This is all good! You don’t need to be an accountant to run your business, you need to calculate and track certain critical criteria. Waiting until the end of your fiscal year to see where you are could be your downfall or you could have changed something you shouldn’t have done because you were more successful than you thought.
The numbers to follow closely are found on the following reports: Balance Sheet, Cash Flow Statement, and Income Statement. Your accountant creates them for you. Hire a good accountant and make sure you understand what you are looking at and what your numbers mean. Learn to read these reports and keep track of critical numbers so you don’t suddenly find yourself on the brink of bankruptcy. Take bold and immediate action when necessary to continue moving toward your income and profit goals.
3 critical financial reasons to track:
Gross margin (also called Gross profit) = Income minus direct costs.
Net income (also called net profit) = Income minus all expenses and taxes.
Ratios of overhead to sales and wages to sales = Total overhead as a percentage of your income and total wages as a percentage of sales.
Now let’s take a look at each of these numbers to understand their importance and how they can affect your business in the short and long term. Your net profit is directly affected by your sales, selling price, and variable and fixed costs. Measure your financial performance regularly to get a clear picture of your financial situation before making drastic decisions.
Large profits or the gross margin represents the profit you have left after deducting the revenue less direct costs. Gross profit is what you have left to pay for indirect costs. Direct costs are the costs associated with your products and services sold. Direct costs include: purchase cost or more, customs, duties, losses, interest paid for the manufacture of the financed product, local delivery (if not invoiced separately), commissions and bonuses, and direct mail costs (if you allocate a budget advertising directly to this article).
You net income or the net profit is your bottom line. This is the amount you have left after deducting all expenses and taxes from your total income. Many forget to count the taxes paid. We have to pay the tax collector, so this should be counted as an expense.
If he general sales expenses or the Salaries to sales the proportions increase, find out why. Many reasons can affect these ratios. Some are temporary and acceptable. Others may indicate a bad trend. For example, if your salary / sales ratio increases because you have just hired a new salesperson, this is acceptable and temporary. However, if after a few months this ratio remains high, there is reason for a more detailed analysis. Did this seller sell anything during this time? If so, do your sales cover your salary? If the answer is yes, it is an indication that sales from other sources are down. Tracking these two ratios on a monthly basis will help you keep costs reasonable and take corrective action before they get out of hand.
“You cannot improve what you do not measure.“
Small business owners are bombarded with outages. It is imperative to stay on top of key financial data on a regular basis. Don’t just rely on instinct or what the staff tells you. Keep track of these numbers and more to get a clear, unbiased picture of where your business is. Take immediate corrective action when necessary to get back on track toward your goals.
You cannot improve what you do not measure. Manage your finances or they will manage you!