Running a successful business is both an art and a science. Yes, it’s important to have a great product and an excellent marketing strategy. But if you’re not tracking the right financial metrics, you may find it hard to reach your growth goals or even remain solvent.
Let’s take a closer look at the importance of tracking financial metrics and which ones business owners should be focused on.
The Importance of Tracking Financial Metrics for Business Owners
Smart money management is what separates a successful business from a failed one. While money management has many moving parts, tracking financial metrics is an important one.
Monitoring your financial metrics gives you valuable insights into your business’s performance and allows you to find:
- Growth opportunities
- Areas for improvement
Financial metrics also help you understand whether you have enough cash to invest in growth, or whether you need to cut expenses to stay solvent.
The Role of Financial Metrics in Decision-Making and Business Success
If you want to run a successful business, you have to do more than just hope for the best. Making decisions based on data – not your gut instinct – will produce the best outcome.
When it comes to decisions like investing in growth or hiring new staff, it’s crucial to let your financial metrics be your guide.
Metrics help you focus on your most important assets and pinpoint areas of improvement. They drive your marketing and financial strategies, too.
Tracking the right metrics can help you understand:
- Which targets you reached
- Which targets you missed
- Which areas can be improved
- Whether you’re on track to reach your future goals
- Your past performance and how it affects your business today
Data-based decision making is all about using metrics to guide your decisions and ensure they align with your goals and initiatives. Taking this approach can lead to business success.
Key Financial Metrics to Track
What are key metrics in business? It depends on the industry. You may follow one metric more than another, but there are five financial metrics that you can be confident every owner follows to understand the health of their company.
1. Revenue
Revenue metrics are often the most exciting because they show how the company generates its money over time. You can use this figure as a loose indication of business growth, but it leaves off profits, which can be negative even if you have a revenue increase.
You can and should monitor:
- Gross revenue from operations
- Monthly recurring revenue if you offer a subscription-based service
For example, a software-as-a-service company may monitor their monthly recurring revenue because it’s a better indicator of growth than revenue for the business model. In addition to your revenue, you’ll need to know your gross profit margin.
2. Gross Profit Margin
Gross profit margin helps you find the financial health of your operations. You'll need to determine this figure using the following data points:
- Net sales
- Cost of goods sold
You'll be able to determine your gross profits by: (net sales – cost of goods sold) / net sales.
Gross profit margins do not account for important information, such as the costs of selling the goods. You may have $20 in gross profit margins for a good, but due to employee hours necessary to make the sale, profits fall to a true value of $4.
3. Net Profit Margin
You can calculate your net profit margin by using the following calculation: (net income / net sales) * 100. The net profit margin metric is a way to understand your total percentage of profit using total revenue.
Unlike gross profit margins, the net profit margin considers all expenses, so it’s a better indicator of the financial health of your business.
If you have a negative profit margin, it is an indicator that your business spends more money than it’s taking in. Drastic changes are necessary to keep operations running if you’re in the negative.
4. Return on Investment (ROI)
If your business is investing in growth or making any kind of investment, it’s important to track your return.
Return on investment, or ROI, is a metric used to evaluate an investment’s performance and is expressed as a percentage.
To calculate your ROI, divide the investment’s net profit or loss by its initial cost. The answer will give you a general idea of the investment’s profitability and whether it’s improving or harming your growth.
5. Cash Flow
Cash flow is one of the most important metrics a business can track. Why? Because positive cash flow is crucial to the survival of your business.
If your company isn’t generating enough cash flow to cover its expenses, then you won’t be in business for long.
Cash flow refers to the movement of cash into (income) and out of (expenses) a business.
Make sure that you’re tracking your:
- Free cash flow
- Operational cash flow
- Working capital
If you find that your cash flow is in the negative, you can take steps now to reverse this trend and get your business back on the right track. For example, negotiating more favorable payment terms with vendors or cutting back on expenses can help improve your cash flow.
How Tracking Financial Metrics Helps in Decision-Making
Key business metrics are useful in decision-making, but you need to track and monitor them. Otherwise, you’re collecting data that you cannot begin to use to guide your business forward or find areas for improvement.
How Tracking Financial Metrics Can Help in Identifying Areas for Improvement
Decisions revolve around improving your business. You might find areas for improvement in helping make your staff more efficient or possibly have to lay off staff because revenue is slowing.
Tracking your financial metrics will allow you to:
- Review what’s working and not working from an objective viewpoint
- Analyze how the metric has changed over time
- Understand how your decisions in the past have led to metric fluctuations
For example, perhaps return on investment has been slower in some segments compared to others. You may even find that the metric is showing negative growth. You can review the data to understand:
- If enough capital has been earmarked for the opportunity
- Opportunity growth or contraction
- Investment validity
Corporations make investments that do not materialize every year. Over two-thirds of startups never produce a return on investment for their investors. You can use the information that you have to decide if it’s worthwhile to invest more money into the segment or if it’s better to cut your losses and walk away.
Areas for improvement may mean earning higher revenue, or it can mean making hard decisions, such as shuttering an investment because it failed.
The data doesn’t lie.
If you have metrics that you follow and track over the long-term, they will empower you to make smarter business decisions. You can also use this information to set and monitor your goals.
How to Use Financial Metrics to Set Goals and Measure Progress Towards Those Goals
Goal setting and projections are “best guesses” for many businesses, especially startups that don’t know the direction of their company just yet. Data changes your ability to set goals because you have:
- Starting points
- Option to track data point changes
Cash flow metrics are the perfect example of how you can set and measure goals. You can review your data and see that your cash flow never exceeds $1,000. Knowing that a single late invoice can lead to accumulating debt and needing to take out a loan, you decide to improve positive cash flow by $4,000.
You have a lot of options to reach this goal:
- Increase the cost of your goods or services
- Reduce costs to improve profit margins
- Secure a line of credit
- Streamline tasks to boost productivity
Now, at the time that you set your goal, you have $1,000 in positive cash flow and decide to streamline operations first. You even put a new invoicing system in place that sends out your invoices once an order is complete.
A month later, you review cash flow metrics and see that it's $2,000.
You can analyze your revenue and net sales data to find that they’re similar to past months. Based on this data, you may determine that your streamlining approach had a positive impact on cash flow.
Progress is measurable when you have data points that you can refer to and see change over time.
Conclusion
Financial metrics tell the “story” behind a business’s operations. You can look at the financials of major corporations, such as Apple, and discover how its operations were in the negative when Steve Jobs and his co-founders were still working in their garage.
Decades later, the same data can help you realize turning points in operations, when product releases were a major success and when they were a failure.
You can create the same story with your own data, monitor it and allow it to pave the future of your operations. When you make data-driven decisions based on metrics, you’re making smarter decisions based on facts rather than emotions.
But before you can begin making these decisions, you need to track the key metrics that are most important for your business and industry.
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