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Did you know that 28% of businesses fail due to problems with the financial structure of the company? This includes keeping poor accounting records.
If you don’t understand your key financial metrics, you have no way of monitoring your business’s health—and you risk mingling assets, incurring penalties for filing taxes late, overlooking expenses, and running into difficulties paying bills and employees, just to mention a few!
It is, therefore, essential to not only understand what each of these key metrics can tell you about the health of your business, but also to monitor how these metrics are performing on an ongoing basis. This will enable you to make better decisions, as well as plan proactively for the future.
Depending on the type of business you operate, the metrics you monitor will differ. For example, if you have an eCommerce website, you’ll want to measure unique visitors, referrals, bounce rate, and similar. If you’re running a subscription business, you’ll want to track churn rate, monthly recurring revenue, lifetime value, and so on.
However, there are a number of metrics that every business owner should know, including cash flow, accounts payable, accounts receivable, direct costs, operating margin, net profit, and cash burn rate.
You can find out more about each one by following the links below. Each article will give you:
- A brief definition of the metric
- In-depth details related to how this metric is calculated
- Information on why it’s important to know this metric
- Tips on how to improve results
If you’re still struggling to understand any of the concepts, let us know in the comments section and we will do our best to explain them in the simplest terms possible.
What Is Cash Flow?
Cash flow measures the money—the actual dollar or pesos or yen—that is moving in and out of your bank accounts. Cash that you pay out is negative cash flow, and cash that comes into your business is positive cash flow. The most important thing to know about cash flow is that it isn’t profits.
What Is Accounts Payable?
Accounts payable is the total of the bills that you have to pay, but that you haven’t paid yet. This is a business’s short-term debt that must be paid. In your company’s financial statements, accounts payable will show up on your balance sheet as a liability. It’s important to track this metric so that you can manage your cash flow. After all, if you can’t manage your debts, you could risk defaulting.
What Is Accounts Receivable?
Accounts receivable is money that is owed to you by your customers for products or services that you’ve sold. Because this metric shows as an asset on your financial statements, it’s especially important to be aware of it. Remember, this is not money in the bank, but money that is owed to your business. Encouraging customers to pay invoices faster will decrease your chance of getting into a “cash crunch.”
What Are Direct Costs?
Direct costs—also known as “costs of goods sold”—are the costs that can be completely attributed to the production of a specific product or service. These costs include the cost of materials used to create the product and potentially any labor costs that are exclusively used to create it. Direct costs always exclude indirect expenses such as marketing expenses, rent, insurance and so on. Direct costs show up on the Profit and Loss Statement and can be subtracted from revenue to calculate the gross margin of a company.
What Is Operating Margin?
Operating margin shows you how good your company is at generating income from normal operations of the business after you’ve spent money on marketing, sales, product development, and so on.
What Is Net Profit?
Net profit is your operating income minus taxes and interest. It is the proverbial bottom line of your business; the money you make that doesn’t go back into expenses, taxes, and interest—the net profit that is left over.
What Is Cash Burn Rate?
Cash burn rate is the rate at which a company uses up its cash reserves or cash balance. This metric is designed to show you how fast you’re burning through your cash reserves or how you’re maintaining a healthy balance from positive cash flow.
At Palo Alto Software, we place a lot of emphasis on tracking business numbers because it makes the decision-making process that much easier. Knowing how you’re performing allows you to take action that is important to continued growth and even the survival of your business.
If you’re looking for tools to help you easily keep track of your key financial metrics, you can use an accounting solution like Quickbooks or Xero, or a business management dashboard like LivePlan. The latter will give you instant insight into each of these key metrics and make it easy to compare data from previous periods.
In the words of our CEO, Sabrina Parsons, “The more you track, the more you track. The more you see data and realize how useful it is when it comes time to make decisions, the easier it will be to actually make decisions. Getting started is the hard part.”