Your Business Report Card
The end of the year is like report card time for your business.
Here are financial metrics that can help you evaluate (and improve) your business.
Income Statement (or Statement of Earnings, or Profit and Loss, or P&L)
Revenue growth – how much did your top line grow in dollars and percentage, this year vs. last year (and prior years). Setting up a spreadsheet to record multi-year results is a great way to analyze performance. How to improve: develop a strong brand and provide high value that will justify higher prices.
Net income growth – you may need to normalize your earnings by backing out unusual items or tax driven items, in order to assess your net income. This is in dollars and as a percentage of revenue. How to improve: Focus on sales, marketing and branding. It’s easier to grow the top line. Manage costs wisely but not microscopically.
EBITA – Earnings before interest, taxes and amortization. Using the normalized net income in 2 above, add back interest, taxes and amortization. This is an important metric for business performance and can be useful to estimate a valuation using a multiple for your industry, multiplied by the EBITA. Note that this is not an approved way to establish what your business is worth for sale or succession – always consult an expert. How to improve: Operating leases will reduce everything – interest, taxes and amortization because you don’t own the asset. Your financing structure influences this significantly.Gross profit – Revenues less cost of sales such as direct labour and materials. What is your gross profit in dollars and gross margin in percentage, compared to prior years? This is most useful if it is calculated by product or service line, as an overall blended number is distorts product line performance.
Overhead expense – what are your general and administrative expenses in dollars and as a percentage of sales. Are you getting more efficient? Sometimes you need to ramp up the management team or systems to grow significantly.
Current ratio – current assets divided by current liabilities. Your banker may include or exclude the current portion of long term debt, so check your financing agreement. A minimum would be 1.25 : 1.0 and the larger this ratio is, the more working capital you have for growth, but the less you are probably growing. A low ratio may indicate rapid growth and, even if profitable, high growth companies can run out of cash long before they run out of enthusiasm or customers. How to improve: hoard cash, invoice quickly, have high profit margins, manage costs carefully, pay suppliers quickly so you get good terms.
Debt to equity ratio – This is the proportion of leverage you have in your business. A maximum for established companies is typically 2.0 : 1.0. Start-ups may be higher than this – temporarily – but need to get within these limits in a couple of years. How to improve: use operating leases for financing as this keeps debt off the balance sheet (you must meet specific criteria – always talk to an expert), maximize profits and pay some tax (the retained earnings will allow you to borrow more and grow more quickly).
My favourite – Days to Cash – How quickly do you convert your labour and materials into cold, hard cash. You pay your employees every two weeks or twice a month, yet your customers only pay you once a month, often after 30 (or more) days. There will always be a gap. The faster you get paid, the more working capital you will have to grow your business. How to improve: invoice ruthlessly and quickly, get paid up front, send out progress billings, pay commissions after your customer has paid you.
The highest performance ratio is Return on Investment, or ROI. It measures your return (net income on the P&L) divided by your investment (equity on the balance sheet). If a zero risk guaranteed investment certificate pays 2% or 3%, then you want to make sure that your hard work and effort is rewarded with an ROI of 10% or 20% or more. One high growth client had an ROI of 85.3%. Those are happy shareholders – that’s an A+