- EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortisation)
It’s a measure of profitability and of your company’s overall financial performance, but can be misleading because it doesn’t include costs for capital investments such as property, plants, and equipment.
EBITDA = net income + interest + taxes + depreciation + amortisation
- Gross profit margin
It’s the amount of revenue that remains after deducting the cost of sales. It is calculated by taking total net sales minus the cost of goods sold and dividing the difference by net sales:
Gross Profit Margin = (Net Sales – Cost Of Goods Sold) / Net Sales
- Net profit margin
It shows what percentage of your sales is actual profit. It is calculated by subtracting business expenses (cost of goods sold, interest on debt, taxes, operating and other expenses), from total revenue, and dividing the result by total revenue (and multiplying by 100 to obtain a percentage):
Net profit margin = (Revenue – Cost of Goods Sold – Operating Expenses – Interest – Taxes) / Revenue x 100
“Good” margins vary considerably by industry, but in general, a 10% net profit margin is considered average, a 20% margin is good, and 5% is low.
- Working capital
It’s the amount of liquid net assets available to fund your company’s day-to-day operations after short-term liabilities have been paid. Working capital is calculated by subtracting current assets (the resources your company owns that can be used up or converted into cash within a year) by current liabilities (the amount of money your company owes, due for payment within a year):
Working Capital = Current Assets – Current Liabilities.
A ratio above 1 means current assets exceed liabilities. Generally, the higher the ratio, the better.
It shows how much of your debt (borrowed funds) is being used to buy assets. Leverage can also refer to the amount of debt a company uses to finance assets. A common formula to calculate it is:
Leverage = Net Debt / EBITDA
- Cash flow
It’s the movement of money into and out of your business, from such things as operations, investing, and financing. Calculating cash flow is simply a matter of comparing cash coming in with cash going out over a time period. Cash flow forecasts are essential to optimise a company’s strategy. The formula for net cash flow is:
Net Cash Flow = Cash Received – Cash Spent.
Using financial KPIs to expand your company and obtain financing
Let’s say you want to expand your business, but you will need financing to do it.
To figure out how much financing you need, look at:
- Your leverage: how much debt are you already using to buy assets? How much more can you take on?
- Working capital: this can partially answer the debt questions because it shows you how much money you have left after paying the costs of running the company.
There are other non-financial risks related to your industry as well. For example, could your supply chain be disrupted? Are you under pressure from pending regulations? This is where trade credit insurance can help protect the investment you’re considering.
No matter how brilliant you believe your project to be, whoever is thinking of lending you the money is going to want to see your business plan and hard numbers – in particular your net profit margin, working capital and cash flow.
Banks are becoming less willing to lend money to SMEs since recent regulatory changes have increased funding costs, so you will need to be persuasive with future projections. For example, if your plan involves a high investment to increase your company’s digital adoption, be prepared to demonstrate how the cost will be amortised by an increase in productivity, making it possible to attract new customers and gain market share.
Use KPIs on a regular basis to stay on top of your financial performance. Here are some suggestions on when to look at what:
- Daily: to manage cash flow and expenses. Remember: cash is king.
- Monthly: to evaluate performance and adjust targets for the immediate future.
- Quarterly: to evaluate seasonal performance and compare this to the same period a year ago.
- Semi-annually: to track and adjust longer-term performance and adjust KPIs as-needed.
- Annually: to understand what changed since you set the year’s goals, and why.
Remember, your objectives will change as your business grows. Your financial and risk literacy should grow, too, so you can be ready to seize future opportunities.
For more tips and advice on business financial monitoring, download our ebook:
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