Why you need to know your numbers
Most people in business are great at what they do but when you talk to them about financial figures they run for the hills.
There are some basic numbers and ratios every business owner just needs to know – and luckily, they are easy and quick. While you may have an accountant, you can never forget as a business owner that responsibility for the financial health of your company rests ultimately with you and you alone and knowing the numbers is critical.
Firstly, though, a caveat – financial numbers should never be looked at in isolation. Either they should be compared to the industry benchmarks and/or should be analysed over time as a trend.
The numbers, ratios and margins are important because they tell us whether your business is making an adequate return and utilising its resources efficiently. An ‘adequate’ return is subjective – what is adequate to one person, one investor, one owner, one banker, or one industry may be different to what others consider adequate.
There are three groups of financial numbers that you should know – profitability numbers, activity numbers, and liquidity numbers. And for the non-accountant here’s the great news – there are in total only ten key numbers that you need know and understand.
Profitability numbers
Profitability numbers most commonly analysed are Gross profit margin ratio, Net profit margin ratio, and Operating profit margin ratio. These three terms are simply a way of expressing profit when different categories of expense are included.
Businesses offering a product or service that is easily replicated or commoditised usually have low margins. Businesses that have a competitive advantage or a barrier to entry usually have high margins. New products usually have a high margin to begin with and as competition increases the margin reduces.
Your profit margins indicate overall financial health and are a quick way of flagging problems. One of the features of any business is the business exists to be profitable. If you look at the profitability numbers and they are low, you can take some quick steps to improve the numbers. This might be through increasing prices, reducing costs, or a combination of the two.
Activity numbers
Activity ratios tell you how efficiently your business is using its short-term assets, especially cash. They indicate your operational performance. If you don’t understand activity ratios, you risk a deterioration in your business’ performance and ultimately your business could fail, and you won’t know if you are managing your cash flow as best you can.
Activity numbers most commonly analysed are Working capital (Current) ratio, Debtor days, Creditor days, and Inventory days (stock turn).
Having lots of capital tied up in inventory and debtors means the business has to find the cash to pay for them from somewhere – either through its own reserves, borrowings or by delaying paying creditors. What is optimal depends on the industry and the products being sold.
Liquidity numbers
The next set of numbers you need to understand to ensure your business is successful are liquidity ratios. These measure your business’ ability to meet its short-term liabilities. In other words, they make sure you can pay your bills.
Liquidity numbers commonly analysed are Current ratio, Quick asset ratio, and Cash ratio.
They are especially important to banks and creditors. You need to know your liquidity ratios are sound when you are applying for loans, and lenders will need to know them before they give you credit.
Liquidity ratios, however, do not look at the timings of liabilities in their calculation which therefore requires a bit more analysis of the ratios than with the productivity and activity ratios.
Being able to calculate and analyse these numbers means you can make decisions quicker and are not waiting on your accountant to produce your financial reports and then book in a meeting to discuss the financial health of your business. By that time the information could be out-of-date, and you might not have the opportunity to rectify the problem.
Stephen Barnes is the principal of management consultancy Byronvale Advisors. He has over 20 years advising clients from new business start-ups to publicly listed companies and across a wide array of industries. He prides himself on quickly understanding the client’s business and issues, and synthesising problems to develop pragmatic solutions. He is also the author of ‘Run Your Business Better – Essential Information Every Business Owner Should Know and Use’. To find out how Stephen can help you run your business better visit www.byronvaleadvisors.com.
alicejohn
November 14, 2017 at 8:54 pm
informative its a really appreciated