As a small business owner, you have plenty of things to keep track of. Pipelines, a loyal customer base, labor costs, training, upkeep of equipment, supplies, finances, taxes, accounting, employee benefits, monthly bank reconciliations, and your overall bottom line pull you in every direction.
Accounting may be the last thing you think about because payroll and account reconciliation are largely automated, so you barely have to think twice. Then you get an alert that something’s not right. Suddenly, you pay more attention to your accounting.
Instead of taking a reactionary approach to your financials, we highly suggest you prioritize three essential accounting metrics you must understand to succeed in the long term.
Related Post: How Your Business Can Perform a Cash Flow Analysis
Labor costs can consume as much as 70% of a company’s expenses, yet a Paycor survey published in December 2022 states HR professionals only spend 15% of their time managing labor costs.
As a small business owner, maybe you’re also the HR department, particularly if you don’t hire very often or have a relatively small staff. Understanding your labor-based metrics may help you save on costs when you find inefficiencies.
If you have a product-based or deliverable-based business model, there are two simple formulas and numbers to examine to see if your labor costs generate enough profits.
The first metric to look at is revenue per FTE. Simply divide your annual/quarterly/monthly revenue by the average FTE to derive this number. If you’re a seasonal company, quarterly reports are appropriate.
Speaking more to your bottom line, your gross profit per employee is a more well-thought-out metric. Find this by dividing your annual/quarterly/monthly gross profit by your average FTE.
Either number gives you a metric to see if your profits are less, more, or what you expect regarding your labor costs. You can also strategize whether or not technological tools and automation can repurpose employee time or if certain departments can be repurposed for other tasks.
Gross Profit Margin
Cash flow is vital, and running that regular metric shows how much cash you might have on hand at any given time. Gross profit margin gives you insight into how much clearance you have above breaking even.
First, start with your variable (or direct) costs rather than overhead. Your overhead costs, like rent, utilities, and loan payments, stay the same no matter how much your revenue fluctuates.
Subtract direct costs from your gross revenue, then divide this figure by the total revenue to get your gross profit margin. The key here is to determine a long-term average for your margins to determine how much above or below normal this figure is. Much like 20-year average highs or lows for weather, you can derive a benchmark as your company moves forward.
You have another metric to compare when examining the health of your gross profit margin. Take a look at your industry’s average profit margin. For restaurants, that might be just 10%. For marketing agencies, that number might hover close to 30%.
Gross profit margin helps you find out what you can do to optimize profits. Labor plays a significant role in your gross profit margin. How much do you pay employees? What about automation? Are you a service-based or product-based business? Can you raise prices to cover higher labor costs?
Your sales cycle also comes into play here. Does it take a year to land a contract, or do you sell products on a daily basis? When you land a new contract, do you have to hire more people or purchase new equipment?
Once you analyze your gross profit margin, you can develop a steady growth strategy that helps your company increase revenue while putting more money in your bank account.
Cash Flow Cycle
Positive cash flows are always desirable. But running a cash flow report only gives you a snapshot of your finances at one moment in time.
Sales and accounts receivable are the two most important factors to look at in a cash flow cycle. As you gather information, you can develop a ratio that shows how much your cash flow changes over time.
First, look at accounts receivable days on hand, or days sales outstanding (DSO), which measures the average number of days it takes to collect invoices. Take our accounts receivable balance divided by annual revenue and multiply by 365. Over time, you’ll see how easy or hard it was to collect on sales.
Second, look at the inverse of DSO, accounts payable days on hand, which is how quickly you pay your expenses. Take the accounts payable balance divided by the annual cost of sales or goods sold (depending on your business model) and multiply by 365.
Comparing your days on hand for accounts receivable and then accounts payable can show you if there are delays in either metric as you optimize your cash flow.
For product-based and procurement-heavy businesses, the average age of inventory is an important metric to measure. Take your average inventory and divide it by the costs of goods sold and multiply by 365 to get the average age of inventory. This metric determines how liquid your inventory is. Do you move a lot of stock in just a week, month, quarter, or year? It depends on how your business operates.
Like other metrics, look at your industry standard to see how well your cash flow cycle metrics stand up to other businesses like yours.
Related Post: 9 Practical Cash Flow Tips for Small Businesses
Who can help my company analyze my accounting metrics?
Analytics programs and platforms offer great ways to mine data from your entire business to give you and your team solid numbers to examine. But you’ll still need humans to show you a way forward as you develop a long-term business strategy.
A business advisor from The Whitlock Co. can help you with insights into your numbers and assist you with the way forward.