Navigating and assessing the performance of your business can be a complicated process. With so many aspects of the business influencing each other, it can be difficult to know where to start.
Elements Advisory Group have narrowed it down to seven key pieces that, when combined, help us see the full picture of a business’s financial health.
Watch the video below to hear partner Darren Van Zyl explore each of these seven indicators.
Learn how they tell a different but equally important part of the story, and together, give us a clear view of the financial history of a business and where it might be headed in the future.
Key Indicators of Business Performance
The first and most obvious is Revenue.
Picture it as the fuel for your business that is needed to keep the financial lifeblood that keeps everything moving.
When assessing revenue performance, we ask questions like:
Has your revenue been climbing over time? If not why? and;
How does that growth compare to your industry averages?
Now, consider the sources.
Are there certain revenue streams that are behaving differently?
If a revenue stream has grown, what was the driver of that behaviour?
Remember, revenue isn’t just a number; it’s the beginning of the story of your business’ growth. So, understanding where your revenue springs from sheds light on your strengths, hints at what your customers really want, and helps shape your pricing strategy.
2. Gross Profit Margin
Next up is your Gross Profit Margin.
Think of this as the first checkpoint in determining your profitability. It shows what’s left of your revenue after covering the direct costs of producing your product or service.
If the margin is deteriorating over time, then it may be time to revisit your costs and pricing.
If you want to improve your Gross Profit Margin, consider increasing your markup or pricing of materials and labour, negotiating better pricing with suppliers, or finding ways to deliver your service more time and cost-effectively.
The Gross Profit Margin is your early warning system, helping you nip financial troubles in the bud before they snowball into larger problems.
3. Operating Expenses
The third indicator of performance is the level of operating expenses or overheads that are required to run your business.
These expenses do not typically contribute to revenue production, they are just necessary to keep the operations of the business running smoothly.
Overheads can more easily be analysed when they are grouped into categories and then expressed as a percentage of your revenue. By doing this, we can understand how much of your revenue is put towards each category of overheads. This helps to identify if your overheads are growing disproportionately to revenue over time.
Why take on the risk and stress of being in business if you cannot produce a profit, right?
The next obvious indicator is profitability, which is The indication of the amount of revenue that remains after paying all direct costs and all operating expenses.
If your business is not profitable, you are not making any return on your investment of time and money. And if your business IS making a profit, it needs to be enough to fund reinvestment into your business, repay debt and fund dividends to owners.
It is important to monitor profitability each month because change and improvement in profitability results can take time to turn around.
5. Breakeven Point
To be profitable, you need to exceed your breakeven point.
The breakeven point is the amount of revenue required to make $0 of profit. At this point, you are making nil profit but nil losses.
It is important that a business operates well above its breakeven point consistently as a business still needs to reinvest in growth, fund debt and pay dividends. If a business is operating at break-even, it won’t be able to do any of those things.
So, make sure you know where your breakeven point is, and make sure you operate well above that point each month.
6. Operating Capital
You need to know how much you have invested in your business and where you have invested that money. Operating capital reflects the net value of assets that are used in the business to generate revenue.
This could include your premises fitout, your machinery or equipment, or, most commonly, your working capital. The important thing to understand is that you need to use those assets as efficiently as possible to generate revenue.
As a company grows, there is a constant need to re-invest in assets that allow it to keep growing.
7. Free Cash Flow
The final and arguably most important is free cash flow.
Free cash flow is the Cash profit that remains before a business services its debt or provides a return to owners.
It is important because if a business cannot produce positive free cash, it will never be able to service its debt, and it will never be able to provide a return to its owners. Banks and investors will look at your free cash flow to assess if your business is a high-level risk or worth investing in.
Think about it: why would someone invest in a business that cannot provide any dividends? Alternatively, why would your bank lend you money if the business cannot produce enough cash to pay the debt back?
So, by monitoring free cash flow, you can understand your business’s ability to “self-fund” growth or whether you are going to need constant capital injections to support its growth.
If you are interested in measuring your business’s financial performance, use these 7 indicators to assess your growth and better understand the potential inhibitors for growth.
Or, if you want advice on how to improve your business performance, our specialist advisory team can conduct a Financial Performance Assessment on your business where we explore these 7 areas of financial performance with actionable insights to improve and grow.