Use Key Performance Indicators to Improve Profits
A profit or loss may be an absolute measure of how well a business is doing, but there are several other important indicators you should watch.
Called "key performance indicators," these commonly used financial calculations can help you find areas where you can improve and increase profits, or warn you of potential problems before you run into serious trouble. Financial management software can automatically track many of these indicators for you, or you can calculate them yourself by setting up simple spreadsheets as in the following examples.
Analyse your cash flow
One of the most important indicators is your cash flow, which measures how much cash is available to spend at a particular time. This is quite different from a profit, because profit figures typically include money that your customers owe you. You should receive that money in the future, but it is not available for you to spend right now.
Many businesses get into trouble because they see they have a sizable net profit and figure they have plenty of money to spend on expansion efforts. It is only after they start bouncing checks that they realise they do not have as much cash as they thought they had.
You can set up a worksheet with Microsoft Excel 2003 to measure cash flow for you. Open a new Excel worksheet, and follow these steps:
Discover your debt/asset ratio
Just as cash flow shows you how much money you actually have to spend, the debt/asset ratio computation shows you how much of your property and equipment really belongs to you.
You may find that the debt-asset ratio is already calculated on your balance sheet. If not, it is easy to calculate. Simply create a formula that takes the sum of all your liabilities and divide that by the sum of all your assets.
Ideally, you want this ratio to be less than 1. If it is much greater than 1, it means somebody else – your bank or lender – owns most of your business. That is fine if your business is expanding, but if that ratio does not come down in time, it could indicate you are getting in over your head. In fact, your entire business could be in jeopardy if too many of your creditors demand repayment.
Track your expenses
There are two ways to boost profits: sell more and spend less. To spend less, you need to know where your money is going.
As you enter your expenses into a Microsoft Excel worksheet, you may want to create a column where you can put each cost into a category, such as labour, manufacturing, administration, taxes and sales. The data analysis tools make it easy to generate totals for each of those categories.
Microsoft Excel will now sort your worksheet, grouping each expense by the category label you assigned to it. It will also list the total cost for each category.
Being able to rank the most expensive aspects of your business alone does not tell you where you should cut costs. However, if you find it costs more to sell your product than it does to make it, you may want to rethink your marketing strategy. Analysing your spending enables you to identify the best saving potential.
Calculate product turnover ratio
Now that you know how much it costs to make your product, you can see how long your goods are spending in storage before they are sold. Granted, this cannot be helped if your business is largely seasonal in nature or if you expect the cost of your raw materials will dramatically increase. For most businesses, however, the turnover ratio is a good measure of how well you are matching demand with supply.
To calculate the turnover ratio, you need the cost of all the goods you sold in a month, quarter or year, and the average inventory over that same period of time. It is likely that the inventory figure is already on your balance sheet.
Divide the cost of your goods by your average inventory. If the resulting number is large, it means you are doing a good job of selling your products shortly after they are made. If it is small, it means your products are spending a lot of time in warehouses. You may be able to boost your profits by more effectively judging demand.
Running a small business is a difficult task, but the right data analysis tools can help you ensure your business is on the right track.