Businesses Must Check These Key Financial Indicators

Guest Post | Jan 17, 2023

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In the face of macroeconomic pressures, running a business appears riskier. Ensuring viability and sustainability can be more challenging amidst the skyrocketing prices. So entrepreneurs must study the historical performance of their business to know what aspects to improve.

The marketing and technical aspects point to the actual production and market demand. But before making new strategies, you must first check your capacity to do so. In this article, we will discuss the financial aspect of a business. We will focus on the key indicators that will give you a precise assessment of your business.

Operating Margin

It is not enough to only observe revenue growth. You must check how it performs relative to costs and expenses. Doing so will give you an idea about how prudent you manage your resources.

Revenues describe volume and demand. Meanwhile, costs and expenses discuss production inputs. Combining the two shows how efficient and sufficient your operating capacity is. Often, Gross Profit Margin is enough to assess the core operations.

But personally, operating margin is a more accurate metric since it includes the amount you spend on labor, research, and marketing strategies. It is more useful when you produce multiple products and services.

Moreover, the operating margin can determine what and how much to produce. Which among the products has the highest demand? Which among them requires more spending? Are the resources proportionate to the available labor?

That being said, you can also check labor productivity to find ways to improve it. The best recruitment agency in Toronto knows what employees need to stay motivated at work. For instance, you can increase your labor expenses on salaries and bonuses. In Canada, labor productivity moved in line with hourly compensation increases in 2Q 2022. Remember, making employees happy can optimize productivity.

Operating Margin= Operating Income / Operating Revenue

Operating Income= Operating Revenue - (Operating Costs + Operating Expenses)

 

Return on Asset

To have a more precise measure of your viability, you may compare net income to assets. By using Return on Asset (ROA), you can check how much revenue your assets generate. It can even show how much net income changes for every $1 asset increment. The higher the ROA, the better. It translates into a more viable and efficient business.

Return on Asset= Net Income / Total Assets

 

Liquidity

There are various means to measure the liquidity of a business. The most typical is the Current ratio, which compares current assets to current liabilities. Yet, the Quick Ratio is more precise since it excludes inventories in the equation. These ratios provide a snapshot of your financial condition to keep track of your current goals. Often, it goes hand-in-hand with the Asset Turnover Ratio and Inventory Turnover Ratio.

For banks, lending, and investment holding businesses, loans and deposits are the lifeblood of the operations. With the Loan-to-Deposit Ratio, you can see how much deposits are loaned to borrowers. You can also set your own margin of safety, a wise move amidst interest rate hikes.

Doing this can ensure adequate reserves in case of defaults or lower collateral value. For more conservative estimates, compare the allowance for bad debts to loans.

Current Ratio= Current Assets / Current Liabilities

Quick Ratio= (Current Assets - Inventories) / Current Liabilities

 

Net Debt/EBITDA

Aside from operational efficiency and liquidity, you must assess sustainability. With the Net Debt/EBITDA Ratio, you can see if your business is already overleveraged. You can also check if earnings are enough to cover borrowings. The ideal ratio should be less than 4x. A negative ratio means borrowings are lower than cash.

Net Debt/EBITDA= (Total Borrowings - Cash and Cash Equivalents) / EBITDA

 

Free Cash Flow 

The Cash Flow Statement shows the actual cash transactions of your business. So, depreciation and amortization, valuations, and other non-cash adjustments are excluded. It is a more accurate presentation of your business performance since they are purely cash transactions. It includes changes both in the Balance Sheet and the Income Statement.

To make it easier, go directly to Free Cash Flow (FCF). It is the net cash inflows from the actual operations after deducting Capital Expenditures (CapEx). It is an essential account since it shows both viability and sustainability.

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To be more accurate, you can even compare it to revenues using the FCF/Sales Ratio. It shows the percentage of sales after deducting cash outflows. In other words, it shows the cash generated from sales to determine its intrinsic value. So, a higher ratio means your business can turn more revenues into cash. You must use it more when expanding or purchasing more properties and equipment.

Free Cash Flow= Cash Flow From Operations - CapEx

 

The Bottom Line

With the looming recession, keeping your business stable has become tougher than ever. A rugged market landscape can disrupt its operations. Yet, you can do something to cushion the blow of these macroeconomic pressures. Prudent financial management will help you make optimal business choices.


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