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I spent an enjoyable day with a dynamic client last week and we got to talking about the importance of being able to interpret financial statements and benchmarking results against industry standards to provide some strategies for business growth – so here is a list of some of the things I spoke about with the client today

Financial Ratios

Financial ratios assist to measure where your business currently stands, where it’s been and where it’s heading. They also help you measure yourself against industry benchmarks, and see how you’re tracking against your business plans – there are a number of ratios you can use but some of the common ones are

Gross Profit Margin

Equation – gross profit/sales

Assesses the profitability of products/services prior to operating expenses – if you sell more than one product/service you should have them listed out in your records so you can assess them more easily – there could be products/services that are bringing your margins down and likewise it could show that you need to concentrate on the more profitable deliverables in your businesses

Operating Expense Ratio

Equation – total expenses/total sales

For every dollar of revenue you earn what is spent on operating expenses

Net Profit Margin

Equation – net income/sales

This shows you in percentage terms the profit your business makes for every $ of income after covering all your operating expenses

Current ratio

Equation  – current assets/current liabilities

This helps to measure the solvency of your business by assessing whether your current assets (unpaid bills, cash at bank etc.) is enough to meet your current liabilities (unpaid bills, tax liabilities, short term loans etc.) as a rule of thumb many banks like this ratio to be 2 or more(in other words your assets are double that of your liabilities) which means you have ample capacity to meet your liabilities

Inventory turnover

Equation – cost of goods sold/inventory

If you sell products then this is a good measure is shows how many times your trading stock is “turned over” (sold and restocked)during a specific period so for example if you spend $100 000 on stock and keep say $10 000 worth of stock on hand then you are turning your inventory over 10 times a year – low figures may means you have money tied up in stock that is not moving and could affect cash flow and higher figures may mean you are not keeping enough trading stock on hand

Return on Owners Equity

Equation  – net income/owners equity

This measures how much your making on the investment you have put into your business – so say you invested $100 000 worth of capital into the business and the business generated net income of $50 000 then your return on owners equity is 50% – this is a great way of comparing whether the investment you have made in your business is comparable to what you may have earned if you had put your money into another investment.

There are many other ratios you can use to measure performance and efficiency over time such as

• Accounts payable turnover
• Accounts Payable period
• Accounts receivable turnover
• Total debt ratio

Benchmarking

Benchmarking is the process of comparing one’s business processes and performance metrics to industry bests and best practices from other companies. Dimensions typically measured are quality, time and cost. In the process of best practice benchmarking, management identifies the best firms in their industry, or in another industry where similar processes exist, and compares the results and processes of those studied (the “targets”) to one’s own results and processes. In this way, they learn how well the targets perform and, more importantly, the business processes that explain why these firms are successful. (Source: https://en.wikipedia.org/wiki/Benchmarking)

The ATO provides benchmarking reports by industry based on data collected from financial returns, they also audit your business performance based on this data – you can find your industry benchmarking data here ATO benchmarking data.

Being able to benchmark your business against industry standards can give you some valuable insight into your business.  You can use these benchmarks to help formulate plans for a new business or to employ strategies for a business growth, set targets, improve business performance. If you Google benchmarking you will also find other companies that sell commercial benchmarking packages and subscriptions – some even link into todays’ cloud accounting software.

Remember you can not manage what you do not measure

I hope this information will assist you in measuring the performance of your business.  Just another way to Love Your Numbers