Fit for Business?

How healthy is your business? You might think things are ticking along nicely, but you need to be sure. Keeping close tabs on your business’ financial performance is the secret to long-term success and that’s where financial Key Performance Indicators (KPIs) come in. By calculating and comparing these five basic figures, you can identify the areas of your business that are fighting fit and those that need some TLC.

 

5 financial KPIs to help your company stay in shape

  1. Gross profit margin

Are you pricing goods or services appropriately? Your gross profit margin should give you a good idea. It’s calculated using the following equation:

The costs deducted from the revenue include direct materials, staff and product overheads, but don’t include general business expenses. This means your gross profit margin needs to be large enough to cover all of your operating costs (and leave you with a decent profit).

2. Net profit

This is your bottom line: the amount of cash left over after you’ve paid all the bills. Take your total revenue and subtract your expenses for the result.

Example of net profit calculation:

Sales: £100,000

Outgoings: (rent, stock, salaries, utilities, etc)

-£80,000

3. Profit margin

Work out what percentage of your revenue is profit and you’ll find it easier to project growth and set goals and benchmarks. The equation is simple:

Average profit margins vary significantly between different industries. Financial services, pharmaceuticals and property, for example, have sky-high profit margins, while others are more modest. Assess your performance against industry standards as well as making your own year-on-year comparison. If the number is particularly high or low compared to earlier years or your competitors’ results, it’s worth investigating the cause.

Net profit: £20,000

It’s vital that your net profit covers your personal needs (including your own salary) and leaves enough to build the reserves you’ll need during slow periods. Many companies borrow money to help smooth out seasonal fluctuations and keep them going during dips. For a more detailed picture, look at the net profit achieved by specific services or products.

4. Ageing accounts receivable

If you send invoices to customers, you should also run an accounts receivable ageing report (standard in most accounting software such as QuickBooks). Some customers will always pay their bills within a month but others may drag their payment out to 90 or 120 days. If this is causing cash flow problems, consider charging interest on overdue accounts or letting slow-paying clients go. You could also consider invoice financing to help you capitalise on outstanding invoices and boost your cash flow.

5. Current ratio

Do you have enough money coming in to pay your bills? Divide your assets by your liabilities for an advanced warning. The result, known as the current ratio, should be a number between 1.5 and 3. Watch out if it falls into the danger zone between 1.5 and 1 – less than one and you won’t have enough cash to settle your debts. If you suspect that your operating expenses have been creeping up, it’s a good idea to compare them to previous years. Run a report using your accounting software to identify the biggest percentage increases over time.

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Meet the author

IPSE
IPSE is the leading association for contractors, consultants, interims, freelancers and the self-employed. We strive to bring our members the most comprehensive and useful range of information and services and all the latest news about what affects your business.