As the New Year is upon us, it is time for all business owners to take stock of the health of their respective companies. Let’s look at the historical performance of the business as a gateway to predict future performance of the business. According to the “Business Ferret” (a monthly financial analysis for Business Owners), there are 12 Key Financial Metrics that every business owners should be guided by as they evaluate the performance of its business:
1. Real Revenue Growth
Real revenue growth shows the real annual growth in revenues adjusted for the effect of annual over-all increases or decreases in the gross profit index. This can be due to increase or decrease in the end pricing to the buyers or due to decreases or increases in the costs of goods sold.
2. Sustainable Revenue Growth
Sustainable revenue growth tells us how much additional annual real revenue growth a business can handle according to the resources in the balance sheet. If your business continues to grow faster than sustainable real revenue growth, it runs out of resources to finance this growth and, eventually, all other current financial operations.
3. Pricing Policy and Pricing Index
A good pricing policy is simply about maintaining your gross profit margin. Maintaining that specific margin is part of your brand identity, whether you know it or not. If your gross profit margin cannot be maintained, what is happening to the business’s brand value?
4. Operating Expense Control
Operating expenses are expressed as a percentage of revenues. This key financial metric is typically compared to net income margin (net income to revenues) and gross profit margin.
5. Comparing EBITDA Versus Cash Flow
When it comes to measuring actual cash flow from your business don’t use EBITDA! This is a very poor place holder for actual cash flow. It can be highly misleading under most situations. Understand how useless EBITDA is in representing cash flow.
6. Debt Free Cash Flow
More specifically debt free cash flow means cash flow before financing but adjusting for any interest expenses paid. By adding back in the tax adjusted interest expense the leverage effect by the use of debt is totally removed. This would be the cleanest form of cash flow that can be followed for the business.
7. Excess Cash
Poor cash management can harm the company’s performance in both subtle and obvious ways. It’s not just having too little or no cash, it is also having too much cash that can negatively affect a business. Holding excess cash can be like increasing the cost of goods without an increase in prices when viewed in relation to return on assets and cost of capital.
8. Return on Assets
Return on Assets (ROA) is calculated by dividing net operating income after tax (but before other income or expenses like interest income or expense) by total assets. Return on assets eliminates the effect of leverage, positive or negative, when a business uses debt financing. In this form ROAs are highly useful in comparing one company to another.
9. Positive, Neutral, and Negative Working Capital
Mismatching the working capital will cause consistent and costly problems for the company. Knowing the potential need for capital in the working capital is an important metric for determining the future financing of the business whether short, medium, or long term.
10. Use of Debt Financing
Few companies can financially function without debt financing and even those that produce enough cash flow to avoid the use of debt should seriously reconsider that choice. Debt financing is generally far cheaper than equity financing, even in the worst of times. Debt financing plays a big role in the company’s cost of capital.
11. Net Trade Cycle
Net trade cycle, or “cash conversion cycle,” tells a great deal about working capital in a business. Net trade cycle calculates how many days and dollars are tied up in accounts receivable and inventory and how many days and dollars of financing is furnished by the accounts payable.
12. Cost of Capital
The Cost of Capital represents how much we’re paying to fund our business through debt and cash. This gives us a benchmark for improving the value of a company.
For additional information about loans, lending or small business planning, especially in Philadelphia, please call Calvin R. Tucker at 215-452-0100 or email me at calvin@wpfsi.com. Visit WPFSI’s website at www.wpfsi.com.
Calvin Tucker is the loan officer for WPFSI. His diverse experience ranges from small & large businesses, commercial & mortgage banking, business development, credit analysis, management, origination, servicing [domestic/ international], and more.
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