Top 5 important financial concepts for your business
Milwaukee small business owners should understand these essential
There is no end to what you could know about your business. Ratios and data points abound. The more you know the better, but there are five key data points you should be able to nail at any time to prove that you are financially literate about your own business.
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1.) PROFIT MARGIN:
What is it? Revenue minus all costs. The money retained by the company after all costs are paid.
Why it is important: You may be in business for all sorts of reasons, but the plain fact of the matter is that if you are not making a profit, you are not actually in business -- you have a hobby. Businesses make a profit. In order to make a profit, you have to understand how your revenue gets from your top line to your bottom line. This entails setting up % of revenue targets for costs of goods sold, gross profit, overhead expenses and net income. The Net Income (bottom line) percentage of revenue is your profit margin.
2.) WAGES AS A PERCENTAGE OF REVENUE:
What is it? The ideal % of revenue spent on staff in order to maximize production and efficiency.
Why is it important? Every part in a machine has its optimal performance point. It is that point at which the stress on it is enough to keep the part running at maximum capacity, but not enough to break or burn it out prematurely. Your staff is the same way. The optimal performance point is for your staff is best measured as a % of revenue. For most restaurants, for example, the optimal point is when staff and salaries (fully loaded) are at or below 30%. For service firms it may be as high as 50%. Tracking this number monthly or quarterly is the best measure of when to hire, or when your people have too much capacity.
3.) WORKING CAPITAL AND CURRENT RATIO:
What is it? Working Capital is your current assets minus your current liabilities. The current ratio is current assets divided by current liabilities.
Why is it important? Working capital is like oxygen -- when run out, you die. This is why very large companies, with holdings and assets worldwide can go out of business -- they don't have liquid cash to pay their short term obligations. It's not the bank debt that kills you, it's the inability to make payroll and pay your suppliers. This is why the most important part of your financial statements is not your P&L, it's your balance sheet. And not the entire balance sheet, but current assets and current liabilities. The quick ratio will tell you how many dollars of current assets (liquid funds) you have for every dollar you owe in the short term. The standard of healthy liquidity is to have at least 1 dollar of current assets for every dollar of current liabilities. A current ratio of .50 to 2 is considered normal. Only when you get well up over 2 should you start thinking about reinvesting that excess cash.
4.) OWNER BENEFIT:
What is it? The total amount of economic benefit that the owner(s) of a company take out of the company in a year.
Why is it important? There are many ways to talk about how much your company is worth to you, but from a monetary point of view, there's no clearer measure than how much economic benefit you derive from owning the company. This is more than just salary. Owner Benefit includes dividends, insurance premiums, auto reimbursement, cell phone plan and anything else you'd have to replace if you left the company. Owner benefit becomes especially important when you begin to consider selling your business, since for most small businesses, the price you will get is very often somewhere in the range of 3 to 5 times your annual owner benefit.
5.) DEBT TO EQUITY RATIO:
What is it? Total liabilities divided by owner's equity.
Why is it important? The glories of small business ownership lie in the independence, freedom and control you have over your own destiny. Debt erodes that control. The bank can have very real influence over your ability to make decisions if they become a significant player on your balance sheet. The debt to equity ratio will help you keep track of who really owns your business -- you or your creditors. While financial leverage can fuel growth and profits, it must be carefully monitored in order to retain that sense of control and rugged individualism that led you to go into business in the first place.
