Measuring your business’ financial performance should be performed with your management team at least annually, if not monthly. Creating a dashboard of key metrics that are the most meaningful to the company can help shape your management team’s focus and create a vision for the year ahead. The only way to drive momentum for your business is to constantly set goals, measure them and track their progress.
The key for 2023 is to maintain flexibility through building a healthy balance sheet. From a financial management perspective, there are four goals companies should focus on amid the current marketplace ‘s increasingly high interest rates and potential for a slowdown in consumer buying:
Working capital: This is the lifeblood of your business as it represents the current assets available to support your current liabilities. This is extremely important to the health of your business as you need working capital to grow, reinvest in the business and have the financial capacity to support that growth. Companies should benchmark this capital as a percentage of revenues generated as compared to their industry.
Debt to equity (leverage): This is an extremely important measure to keep an eye on due to an increasing interest rate environment. Debt can be used as a working capital vehicle to make investments in property and equipment, talent, acquisitions or additional inventory needed to support revenue growth. These are all great investments; however, increasing interest rates are creating higher costs of capital and longer periods for companies to get the return on investment they desire. Maintaining a healthy debt-to-equity ratio is important to managing the overall risk of the business.
Return on equity: For most of our clients, their business is their largest financial asset. With that, we try to help them view the return on the investment they have in the business the same as any personal investment they make. Owners should review the benefits of having capital tied up in the company, versus diversifying those funds into other personal investments. Ultimately, if the business is financially healthy, and can operate without additional financial support, owners should review where the best use of their capital belongs.
Cash conversion cycle: This is an all-encompassing ratio that measures working capital assets and how quickly those assets turn into cash. The formula is:
Number of days of inventory outstanding + (plus) the days’ sales outstanding – (minus) days’ payables outstanding.
Compute the time frame it takes to buy inventory, sell that inventory, convert the accounts receivable into cash collections, less the time frame to pay vendors and operational payables. We are seeing our clients’ customers start to ask for more extended terms and stretch out their receivables, so businesses should always monitor this in conjunction with how they manage their payable cycles. This will help clients manage their cash flow cycle and reduce their overall interest rate expense.
These are four financial metrics to consider as you monitor the financial health of your business. The plan for you and your business – from planning an exit strategy and trying to maximize value, to diversifying company funds and personal wealth, to reinvesting and growing the business – will depend on the outcome you are trying to achieve, so these benchmarks should have a different focus. None of these can be achieved without setting targets and measuring results against those goals.
For more information on implementing financial metrics in your business, please contact a member of Citrin Cooperman’s Manufacturing and Distribution Practice or Mark Henry at email@example.com.
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