7 Ways to Measure Financial Performance
7 Ways to Measure Financial Performance
7 Ways to Measure Financial Performance
7 Ways to Measure FinancialPerformance
How's your business doing financially?
If you're not sure what else to say after answering "Great!", "OK", or "Terribly!" Don't worry, you're not alone. The question seems simple but there are many ways to answer it.
Below are seven ways to answer that question and measure the financial performance of your business, and seven places to look to answer that question.
From your financial statements
1. Profit
"How much money are we making?" Find the answer on your P&L (Profit and Loss Statement aka Income Statement). Profit describes how much wealth your company created (profit) or consumed (loss) over a certain period of time. Other words for profit are earnings, net income, and the bottom line. A full measurement of profit must include owner's compensation. More profit is good.
2. Cash flow
The difference between the cash you end up with at the end of a certain period of time versus how much you started with. More and positive cash flow is good. Cash flow is decidedly NOT the same as profit. It's a simple (once you get it), but elusive concept. Lots of articles on the web will explain the difference, but in a nutshell: start with the net income on your P&L, make plus or minus adjustments for things that happen on the balance sheet, and you end up with cash flow.
3. Balance sheet strength
More assets (what your company owns) and fewer liabilities (what your company owes) result in a stronger balance sheet. A stronger balance sheet gives your company a survival safety cushion, makes it easier to borrow money, and means your company will command a higher price when you sell it. It's possible to have too strong a balance sheet, but most entrepreneurs don't need to worry about that.
Business items not found on your financial statements
4. Risk
Business is risky. You might not get paid by a customer, you might default on a bank loan, or your company might get sued. Risk is sometimes defined as probability times consequence; the likelihood of something occurring multiplied by the damage it would cause if it does occur. To earn the same dollar of profit with less risk is good. Or, to earn more profit with the same amount of risk is good. Hence, the risk/reward relationship.
Risk is often not priced correctly, as we learned all too well through the collapse of gigantic U.S. financial institutions during the 2008-2010 recession.
5. Owner's time invested
How many hours per day, week, month, and year do you put into your business? Investing less of your time while earning the same dollar of profit is good.
6. Valuation
What is the fair market value (FMV) of your business? Is it rising or falling? In addition to providing current income, businesses create wealth for their owners by having a resale value. When it comes time for you to sell your business (whole, or in part), a higher business valuation is better.
Personal, not business finance
7. Business owner's net worth
One purpose of a business is to create wealth for its owners. Does the owner(s) have substantial investments in retirement accounts, real estate, and other holdings? Has the owner's net worth increased as a result of money she/he has taken out of the business? Look to the owner's personal balance sheet for a full understanding of a small business' financial performance.
Seven measures, seven ways to improve performance
Why bother analyzing how your company is doing financially? The simple act of looking at the numbers every month is likely to make the numbers get better. You'll make more money just by paying attention to the numbers because you'll start to make different decisions upstream, when you're buying and selling things. Those decisions then flow downstream to generate better financial results and put more money in your pocket.
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