Do you find it challenging to decipher which numbers are crucial for your business’s success? You are not alone. Many business owners struggle with understanding the financial reports generated by their accounting software and identifying the key numbers that drive profit and cash flow.
Most standard financial reports, such as the Profit and Loss Statement and Balance Sheet, are primarily designed for tax purposes and may not provide the critical financial drivers needed for effective management. However, there are seven key numbers that are essential for profitability and cash flow, and they may not be included in your standard financial reports.
Let’s take a closer look at these seven key numbers and why they are critical for your business’s financial success.
Revenue Growth %
Revenue growth is a key focus for most businesses, but it’s equally important to understand the costs associated with that growth. As soon as you make a sale, there are costs involved, such as goods for sale, labour, overheads, and more. It’s crucial to know these costs as if they exceed your revenue, you may be operating at a loss and heading for cash flow problems. Revenue growth can sometimes be a double-edged sword for small businesses, as it can exacerbate profitability and cash flow issues if other key numbers are not managed effectively. Therefore, it’s important to celebrate revenue growth, but also exercise caution and strategic planning.
Price Change %
The percentage increase or decrease at which you sell your products or services is another critical factor. In a highly competitive marketplace, it’s tempting to lower prices to attract customers. However, if you’re not covering your costs at the current prices, it’s unsustainable in the long run. Regularly reviewing and adjusting prices, even by small amounts such as the Consumer Price Index (CPI), can prevent margin squeeze, where reduced revenue fails to cover the costs of delivering goods or services. Incremental price increases can be easier for customers to accept compared to sudden, large increases, and modelling shows that increased prices may not result in as many lost customers as feared. In fact, it could have a positive impact on the bottom line by improving gross profit.
Cost of Goods Sold (COGS) %
COGS refers to the costs incurred to get the product or service to the customer before accounting for overheads. It’s also known as direct costs or variable costs. COGS has a significant impact on gross profit, and a small reduction in COGS percentage can have as much impact on profitability as a large increase in revenue. Reviewing and negotiating with suppliers for better prices, or optimizing work practices for service-based businesses, can result in substantial improvements in gross profit. Identifying differences between labour hours sold and labour hours paid for can also reveal opportunities for process improvement.
Many business owners focus on overheads in the Profit and Loss Statement, but it’s important to compare them relative to revenue (as a percentage) to assess their impact on profitability. Looking only at the dollar amount of overheads may not provide an accurate picture of your business’s financial health. Increasing revenue without a corresponding increase in net profit may indicate that overheads are eating into your profitability. Monitoring and managing overheads as a percentage of revenue can help identify areas where cost savings can be made, improving your bottom line.
Days Receivable refers to the average number of days it takes for your business to collect payments from customers after a sale. It’s a critical metric for cash flow management, as longer days receivable can strain your working capital and cash flow, while shorter days receivable can improve cash flow and liquidity. Monitoring days receivable and implementing effective credit management practices, such as timely invoicing and follow-up on overdue payments, can help you collect payments faster and improve your cash flow position.
Days Payable is the average number of days it takes for your business to pay its vendors or suppliers after receiving goods or services. It’s an important metric for managing your business’s cash flow, as longer days payable can provide you with more time to pay your bills, thus conserving your cash, while shorter days payable means you’re paying your bills sooner and impacting your cash flow negatively. Monitoring days payable and optimizing your payment terms with vendors can help you manage your cash flow effectively.
Also known as Inventory Days or Days Sales of Inventory (DSI), Days Inventory is the average number of days it takes for your business to sell its entire inventory. It’s a crucial metric for managing your inventory levels and cash flow, as excessive inventory levels can tie up your working capital and strain your cash flow, while low inventory levels can lead to stockouts and lost sales opportunities. Monitoring days inventory and implementing effective inventory management practices, such as demand forecasting, inventory turnover analysis, and just-in-time (JIT) inventory management, can help you optimise your inventory levels and improve your cash flow.
Keeping a close eye on key numbers in your business can significantly impact your bottom line. By being strategic with Revenue Growth, Price Change, COGS, Overheads, Days Receivable, Days Payable, and Days Inventory, you can uncover hidden profits and cash opportunities. Remember, effective financial management is essential for thriving in today’s competitive business landscape.
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