I spent an enjoyable day with a dynamic client last week and we got to talking about the importance of being able to interpret financial statements and benchmarking results against industry standards to provide some strategies for business growth – so
here is a list of some of the things I spoke about with the client today
Financial ratios assist to measure where your business currently stands, where it’s been and where it’s heading. They also help you measure yourself against industry benchmarks, and see how you’re tracking against your business plans – there are a number of ratios you can use but some of the common ones are
Gross Proﬁt Margin
Equation – gross proﬁt/sales
Assesses the proﬁtability of products/services prior to operating expenses – if you sell more than one product/service you should have them listed out in your records so you can assess them more easily – there could be products/services that are bringing your margins down and likewise it could show that you need to concentrate on the more proﬁtable deliverables in your businesses
Operating Expense Ratio
Equation – total expenses/total sales
For every dollar of revenue you earn what is spent on operating expenses
Net Proﬁt Margin
Equation – net income/sales
This shows you in percentage terms the proﬁt your business makes for every $ of income after covering all your operating expenses
Equation – current assets/current liabilities
This helps to measure the solvency of your business by assessing whether your current assets (unpaid bills, cash at bank etc.) is enough to meet your current liabilities (unpaid bills, tax liabilities, short term loans etc.) as a rule of thumb many banks like this ratio to be 2 or more(in other words your assets are double that of your liabilities) which means you have ample capacity to meet your liabilities
Equation – cost of goods sold/inventory
If you sell products then this is a good measure is shows how many times your trading stock is “turned over” (sold and restocked)during a speciﬁc period so for example if you spend $100 000 on stock and keep say $10 000 worth of stock on hand then you are turning your inventory over 10 times a year – low ﬁgures may means you have money tied up in stock that is not moving and could aﬀect cash ﬂow and higher ﬁgures may mean you are not keeping enough trading stock on hand
Return on Owners Equity
Equation – net income/owners equity
This measures how much your making on the investment you have put into your business – so say you invested $100 000 worth of capital into the business and the business generated net income of $50 000 then your return on owners equity is 50% – this is a great way of comparing whether the investment you have made in your business is comparable to what you may have earned if you had put your money into another investment.
There are many other ratios you can use to measure performance and eﬃciency over time such as
- Accounts payable turnover
- Accounts Payable period
- Accounts receivable turnover
- Total debt ratio
Benchmarking is the process of comparing one’s business processes and performance metrics to industry bests and best practices from other companies. Dimensions typically measured are quality, time and cost. In the process of best practice benchmarking, management identifies the best firms in their industry, or in another industry where similar processes exist, and compares the results and processes of those studied (the “targets”) to one’s own results and processes. In this way, they learn how well the targets perform and, more importantly, the business processes that explain why these firms are successful. (Source: https://en.wikipedia.org/wiki/Benchmarking)
The ATO provides benchmarking reports by industry based on data collected from financial returns, they also audit your business performance based on this data – you can find your industry benchmarking data here ATO benchmarking data.
Being able to benchmark your business against industry standards can give you some valuable insight into your business. You can use these benchmarks to help formulate plans for a new business or to employ strategies for a business growth, set targets, improve business performance. If you Google benchmarking you will also find other companies that sell commercial benchmarking packages and subscriptions – some even link into todays’ cloud accounting software.
Remember you can not manage what you do not measure
I hope this information will assist you in measuring the performance of your business. Just another way to Love Your Numbers
Director, Love Your Numbers
About The Author
A self-confessed "geek girl", Leanne is driven both by numbers and technology, and how the two elements can work together for the good of a client's business. She thrives on problem-solving and encourages and assists clients to derive more from their accounting and other integrated software and systems. She loves your numbers, while you love your business.
Leanne is an MYOB Gold Partner, Xero Silver Partner and a Fellow of The Institute of Certified Bookkeepers. She is passionate about using the best cloud accounting tools, add-ons and platforms to ensure her clients are maximising their time, systems and processes.
A social media "junkie", Leanne is always investigating new ways to use these online platforms for the benefit of her business, other bookkeepers and her clients. Beyond bookkeeping, Leanne is an expert business mentor, trainer and facilitator.
In her spare time, Leanne develops and writes MYOB training manuals for Software Publications. These manuals are used throughout Australia for the Certificate IV in Financial Services (Bookkeeping) & (Accounting). When not working, Leanne enjoys spending time with her daughter Brodie and her beautiful golden labs Bella and Cooper.