June 8, 2012

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Is your business successful? If so, how do you know?

If you’re like most small business owners, your days are filled by efforts to make your company successful. Those tasks might be focused on making a great product, generating sales, or building customer relationships. And you might be great at those things.

But how great are you at making money? And how well are you managing your resources?

While different people have various definitions of business success, there are five key financial metrics that can help you understand your business’ financial success and how you’re faring against competitors:

1. Pre-tax net profit margin
2. Current ratio
3. Quick ratio
4. Accounts payable days
5. Accounts receivable days

If you have someone preparing financial statements or tax returns for you, they should be able to provide these metrics easily, as well as give you additional context.

1. Pre-tax net profit margin

This metric is probably the most important, because it tells the owner how much profit you’re making from every dollar in sales. For private companies, it is usually expressed as net profit before taxes in a given financial period divided by sales.

“A higher margin, or higher profitability, is better for a company’s profit picture,” said Brad Schaefer, an analyst with Sageworks Inc., a financial information company that provides financial analysis and benchmarking applications to accounting firms and private companies. “This number can show you how effective you’re being with expenses and if you should decrease certain expenses so that they don’t eat up as much of the revenues.”

2. Current ratio and quick ratio

These two metrics are considered fundamental liquidity ratios, or ratios that give an idea of how well you can meet your obligations, and they should generally be analyzed together. “If the business does not have decent liquidity, then one unexpected expense could severely hurt it,” Schaefer said.

Current ratio is expressed as current assets divided by current liabilities. It basically shows whether the assets that you can convert into cash quickly (within a year) will cover what you must pay off soon (in less than a year).

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