How to Use Financial Metrics to Measure Success of a Small Business

Small businesses are vulnerable to various threats that can impact their bottom lines. The most common problem is the lack of financial literacy, which can even lead to insolvency. While entrepreneurs are busy chasing profits, they get derailed into investing huge amounts in a risk-filled project that backfires. It happens because of half-baked financial knowledge that makes entrepreneurs get into bad debts and negative cash flow. An easy way out of this predicament is making informed decisions based on the financial health of the business.

Entrepreneurs must acquaint themselves with all the required financial information to stay updated. They must know how the business is performing and how much money they can spend. Aspiring entrepreneurs looking for businesses for sale in Sydney must also be aware of the incomings to check their feasibility. These ventures should have cash reserves to withstand turbulences that can lead to downtime. Here is how entrepreneurs can use financial metrics to keep track of business success and failures. Every entrepreneur needs to gain this knowledge to stay profitable.

1. Determine the Business Revenue

Revenue is an important metric that can be used to identify a business's success. It gives an insight into the income in a year through sales of its products, interest, and rental income from business assets. The metric helps to understand and compare the business's performance with its previous performances. It provides information about the products loved by customers and those not generating the desired interest.

Revenue does not take into account the expenses incurred to generate this income and thus is known as net income which is different from profit. Thus, revenue = price of goods sold x number of units sold. It can be divided into operating and non-operating revenue. The latter is earned through sources other than business operations, such as rent from leased commercial property. Operating revenue is earned through business operations, such as selling goods and services.

2. Keep Track of Business Expenses

Business expenses must be tracked carefully to understand outgoings and how they can be minimised to boost profits. Tracking costs is vital to identifying unnecessary expenses that can be eliminated to make the business more profitable. Most budding entrepreneurs who plan to buy a Sydney business for sale must check the operating overheads to gauge the amount needed for smooth functioning and bill payment.

Business expenses are of two types – cost of goods sold and operating overheads. The latter include salaries, utility bills, commercial leases, insurance, taxes, maintenance, business travel, licenses and permits, etc. Some of them are fixed and others are variable, which keep changing. Most business expenses are tax deductible, but the owner must have accurate records and bills to claim them.

3. Identifying the Cash Flow

Entrepreneurs who wish to buy a business for sale in Sydney must check its cash flow during the due diligence process. This ensures they are investing in a viable entity with the potential to grow and prosper. Cash flow is a significant metric for identifying business success. A positive cash flow indicates that the business can easily pay its bills and shareholders while reinvesting in the business and creating a cash reserve.

Conversely, a negative cash flow indicates financial distress because spending is greater than income. It can be determined through the following formula: net cash flow = total cash inflows—total cash outflows. This formula helps entrepreneurs identify the amount they can spend and make informed financial decisions, similar to using data analytics for strategy making.

4. Calculating the Net profit of the Entity

Net profit must be calculated to identify the income generated by the business after deducting expenses in a given period. Thus, net profit = total revenue – total expenses. It takes the depreciation of assets and taxes into account while calculating total expenses, which makes it a highly accurate metric for business success.

The net profit margin or net profit ratio is another metric used to review business performance. It helps understand the efficiency of spending achieved by the entity. The formula for net profit ratio is (net profit / net sales) x 100.

5. Evaluating Return on Investment

Return on investment is a critical metric that can help business owners identify the venture's profitability by indicating the gain or loss made over the initial investment. It can also be used to check stock returns and other investments. The ROI formula is (net return on investment/cost of investment) x 100. It is calculated as a percentage, and high ROI indicates profits while low indicates losses. It is valuable when assessing the ROI for marketing initiatives to ensure the budget is used efficiently and is not wasted.

6. Check the Cost of Customer Acquisition

Most business owners ignore this metric, but it is quite informative as it helps them understand expenses and income more deeply. The cost of customer acquisition informs about the value of customers and the returns generated through the investment made in them. The acquisition cost should not exceed the customer's lifetime value to maintain profitability.

The cost of customer acquisition is calculated by this formula: (cost of sales + cost of marketing) / number of new customers. Businesses must focus on reducing the cost of acquisition to improve revenue. This is the reason why customer retention is considered more favourable than customer acquisition. The metric lets the business owners know how much they can spend to attract new customers.

7. Assessing Gross Profit and Gross Margin

It is essential to calculate and understand gross profit. It is determined by deducting the cost of goods sold from total sales in a given period. It does not include operating overheads and income generated from non-operating sources. The metric specifically identifies the efficiency of generating revenue from the sale of goods.

Entrepreneurs looking for a business for sale Sydney must also check the gross margin, which indicates its financial well-being. Gross margin is calculated by deducting direct expenses from the business revenue. The formula is as follows: (Gross Profit / Net Sales) × 100. Business owners can use accounting tools to track these metrics.

Wrapping Up

Business ownership is not easy. It requires delving deep into the financial aspects of managing and operating a business. Entrepreneurs must track their income and expenses and monitor the financial statements and metrics to determine the entity’s stability.