We are often asked about the sort of financial information that should be monitored by business owners. Financial metrics as a quick and easy way to check profitability and to use as an early warning system for any potential issues.
There are any number of different metrics that can be utilised and some are specific just to your business. However, there are three that stand out for us that should apply to any business regardless of the type or size. So we have put together a brief “101” on management accounting – and our apologies in advance but it includes a little bit of maths.
This is probably the most important metric of the lot. it measures your ability to pay your immediate debts.
It involves totaling all your current assets like cash (or cash equivalents) and dividing that by your current liabilities. Current liabilities include rent, wages, accounts payable and the like. The formula is really simple:
Cash + Accounts Receivable
You’ll notice that we exclude inventory (stock) because this can’t necessarily be converted into cash quickly.
If the result is less than 1, you have a liquidity problem. If it’s over 1, you have more cash than your immediate needs.
Gross Margin is a quick check to see if you are making enough cash to cover the running costs of your business.
You’ll need to understand you Cost of Goods Sold (direct costs like labour and materials). The simple equation is:
Sales – Cost of Goods Sold x 100
Example: A manufacturing company has sales of $1,250,000 and Cost of Goods Sold of $675,000.
$1,250,000 – $675,000 x 100 = 46%
This calculation will give you a percentage and this is your margin. We have access to a whole lot of statistics which enables us to compare this to other businesses in the same industry as you. This is called benchmaking and it’s really helpful to determine if you are charging enough.
Do you know how long it takes for your customers to pay you? Most people don’t so don’t worry too much if you can’t answer this. Your business is not a bank. The longer it takes to get paid, the harder it is to meet your obligations to suppliers.
This calculation will enable you to quickly compare whether or not your debtors are paying you more quickly or more slowly when compared with a previous period.
Debtors (accounts receivable)
Example: Your Debtors are $60,000 and your sales are $180,000.
It is taking this business 122 days to be paid – that’s way too long.
An increasing number of clients are asking us to prepare quarterly or monthly management accounts for review. We include a large number of metrics and financial analysis with this service and present it in a really easy-to-understand way. It also means that we meet with you regularly throughout the year.
If we are just managing your tax, we only meet with you annually. At that meeting we sit down to review what is by then your historic performance. The information can be months out of date.
Regular meetings throughout the year will help you to achieve more profitability and address any problems early. We offer some really affordable packages so please get in touch to learn more. We know how lonely it can be in business at times and regular meetings will ensure we have your back. For the month of November, we are offering a one hour meeting and a comprehensive report* analysing over twenty different areas of your business for absolutely no charge. Contact us today.