Deciding to open a new business comes with a set of responsibilities. Obviously, providing a good service to your clients and building up a customer base are important. But so is understanding the financial concepts you need to know and measure to be sure your business is profitable and staying on track.
In general, businesses should have enough cash on hand to cover at least 60-90 days of expenses. One way to do this is by proactively applying for a business line of credit to use as an emergency backup. Other steps to take include being sure you understand all the terms and limitations in any contracts or leases you sign, not spending frivolously, not being afraid to ask for help when it is needed and becoming familiar with the numbers you need to monitor. Here are a few key indicators that all new business owners should track.
Cash flow
It is a simple fact: Your business cannot operate without enough cash to pay its expenses, including operating, manufacturing and marketing expenses. It does not matter how many sales you make or how many dollars those sales add up to on paper if you cannot do that. Some common cash flow problems stem from clients who don’t pay on a schedule that works with your bills or investments that tie up more money than you can spare. Monitor your cash flow on at least a weekly basis.
Gross revenue vs. gross profit
Gross revenue is the amount of money the business earns without consideration of any related expenses, such as manufacturing or labor. Gross profit is the amount of money the business has left after the costs associated with producing goods or services are subtracted.
Gross profit vs. net profit
Gross profit is the amount of money the business has before the costs associated with producing goods or services are subtracted. Net profit is the amount of money the business has left after the costs associated with producing goods or services are subtracted.
Gross margin vs. net margin
The higher the margin, the more revenue is generated for each dollar of cost, which means the company is operating efficiently. Gross margin is the percentage of revenue the company has before the costs of producing goods or services are subtracted. Net margin is the percentage of revenue the company has left after these costs are subtracted.
Accounts receivable and accounts payable
Accounts receivable refers to the money companies or clients owe your company. An important element of a company’s success is managing its accounts receivable by having robust processes and procedures in place to ensure timely payments. Being paid on time means having the cash on hand the company needs to continue operating, so it is important to stay on top of who owes money and how much they owe.
Accounts payable are the expenses and costs your company spends to stay in business. For the most part, keeping costs and expenses as low as possible is the goal. But it is also important to recognize the difference between want and need in order to understand when new expenses are warranted. Suppose, for example, that a new business gets to the point where hiring bookkeeping help makes sense. That is a good thing, but what is really needed? Is there enough work to support hiring a full-time employee or would it be more cost-effective to outsource the work or hire someone part time?
Interpreting the numbers
Each of these metrics is valuable because each provides a different perspective on the company’s performance over time. Essentially, each offers a snapshot of a specific aspect of a business’s performance. To provide a fuller picture, each must be monitored regularly and compared period over period. Doing so will reveal trends that are essential to the business’s overall financial health.
Contact Edwards, Ellis & Assoc for professional advice for small business owners.
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