Why Incentivizing People with a Revenue Goal is Like Rolling the Dice
As a business consultant, I’ve seen my fair share of companies attempt to use metrics and incentives to drive performance.
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Running a successful business requires more than just a great product or service. It demands a keen understanding of the financial health of your enterprise. To achieve this, business owners must track specific financial metrics that provide insights into profitability, efficiency, and growth potential.
While I’m not a CPA or financial guru, I am a CEO and a business nerd, and I love studying financial metrics as the crystal ball that helps us see things we otherwise would not. I like to distill the accountant’s framework into simple steps that make it easy to understand.
With that said, these are the top financial metrics every business owner should keep an eye on.
Operating revenue, or sales generated from normal business operations, is the starting point for assessing financial performance. Regularly monitoring revenue helps you understand the demand for your products or services and gauge the overall growth trajectory of your business.
Most businesses generate operating revenue in a few different ways and should be segmented accordingly. Revenue for each product and each service should be tracked separately and collectively in order to analyze seasonal trends and evaluate them for adaptive opportunities.
Why it matters: Consistent revenue growth is a positive indicator of business health and market demand. It also provides the funds needed to cover expenses and invest in future growth.
Gross profit margin, different from net profit margin, is calculated by subtracting the cost of goods sold (COGS) from revenue and dividing the result by revenue. It represents the percentage of revenue that exceeds the cost of producing your goods or services.
Why it matters: The name of the game here is efficiency. This metric reveals how efficiently a company is producing its goods or services as compared to its sales. To help understand this efficiency, it is calculated before SG&A expenses (Selling, General & Administrative). A higher gross profit margin indicates better efficiency and profitability.
Net profit margin, also known as net income, measures the percentage of revenue that remains as profit after all expenses, taxes, and interest have been deducted.
Why it matters: It provides a comprehensive look at overall profitability, showing how much of each dollar earned translates into actual profit. A higher net profit margin indicates a more financially healthy and stable business. If gross profit is healthy but net profit is not, it can be an indicator to study SG&A expenses with more scrutiny.
Operating cash flow (OCF) is the cash generated from normal business operations. It is calculated by adjusting net income for non-cash items such as depreciation and changes in working capital.
Why it matters: OCF indicates whether a company can generate sufficient cash flow to maintain and grow its operations. Positive cash flow is essential for meeting short-term liabilities and investing in future growth. This can be especially critical to monitor when operating notes and business loans with high interest rates pose a threat to overall financial health.
The current ratio is a liquidity ratio that measures a company’s ability to pay short-term obligations with its current assets.
Why it matters: A current ratio above 1 indicates that a company has more value in current assets than its current liabilities, signifying good short-term financial health. It helps assess the company’s capability to pay off its debts as they come due.
The debt-to-equity ratio measures the relative proportion of shareholders’ equity and debt used to finance a company’s assets.
Why it matters: This ratio indicates the level of financial leverage being used by the company. A high debt-to-equity ratio may suggest that a company is heavily reliant on debt to finance its operations, which can be risky in volatile markets and a weak economy.
Accounts receivable turnover measures how efficiently a company collects revenue from its credit sales.
Why it matters: This metric shows how effective a company is at collecting its receivables. A higher turnover rate indicates efficient collection processes and a lower risk of bad debts. Improving accounts receivable related processes is an often forgotten tactic for improving cash flow and profit. Ignore this one, and it can get away from you.
Inventory turnover measures how quickly a company’s inventory is sold and replaced over a period.
Why it matters: A high inventory turnover rate suggests that a company is efficiently managing its inventory levels and that products are being sold quickly. This can help reduce holding costs (cost of capital in tied up inventory + operational cost of holding it) and increase profitability.
Return on equity measures a company’s profitability by revealing how much profit a company generates with the money shareholders have invested. When purchasing or selling a real estate investment, usually with rental income, the ROE is also known as the Cap Rate. In this case, the net is divided by the purchase price, then multiplied by 100 to get the Cap Rate percentage.
Why it matters: ROE is a key indicator of financial performance, providing insights into how effectively a company is using its equity base to generate profits. Owners, shareholders or investors watch ROE to determine if they want to continue funding the business.
Customer acquisition cost is the total cost of acquiring a new customer, including marketing and sales expenses.
Why it matters: Understanding CAC helps businesses determine the effectiveness of their marketing strategies and ensure that the cost of acquiring customers is sustainable in the long term. When customer acquisition costs are high without seeing a positive sales growth trend, it could be time to adapt.
Tracking the above 10 financial metrics is crucial for maintaining the financial health of your business and making informed decisions. Regularly reviewing the trends will provide you with valuable insights into your business’s performance, helping you identify strengths, weaknesses, and opportunities for growth. By keeping a close eye on these key indicators, you can steer your business towards long-term success and profitability.
If you are ready for a financial health assessment for your business, please set up a call to learn more.
Jocelyn Wallace is a Fractional COO for hire, and founder of Profit Plus Business Advisors, an advisory firm that helps business owners maximize profitability and valuation.
If you are ready for a financial and operational health assessment for your business, please set up a call to learn more.
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