Do you wish to unleash the Basic Accounting Metrics at your next Board Meeting? Read on for your guide to financial mastery, sort of.
Accounting is one of the oldest professions in the World, but fast forward a few (seven) thousand years, and while the tools have evolved (depending on which Accountancy Practice you work with), the core principles remain.
In today’s business world, understanding accounting metrics and dashboards has become a crucial tool for navigating your business success.
Are you ready to elevate your financial savvy? Let’s dive into the essential accounting metrics you need for your next board report.
Accounting Metrics: What Are They?
Accounting metrics are (often) simple KPI’s (Key Performance Indicators) which measure performance, allowing you to track and compare your current standing.
These metrics provide insights into various aspects of a company’s operations, helping stakeholders make informed decisions. They encompass everything from revenue and profit to liquidity ratios and return on investment.
Think of your business as an aeroplane (and you’re the pilot!). Financial metrics are the instrument panel, providing potentially real-time data on everything from speed (revenue) to fuel efficiency (cash burn rate).
Without these metrics, you’re flying blind. You might be burning through cash (fuel) without realising it, or worse, nearing a total disaster (insolvency) without warning.
The Power of Numbers: Why We Use Accounting Metrics
Accounting metrics are the backbone of financial analysis. They help businesses:
- Communicate: There’s no need to re-invent the wheel. You can present metrics that colleagues and investors already know to illustrate a clear picture of the company’s current, previous or forecasted performance.
- Measure Performance: Track progress towards your goals
- Informed Decision-Making: Provide data-driven insights for strategic planning
- Ensure Accountability: Incentivise and share progress with colleagues
Why Comparatives in Accounting Metrics Are Vital
So, you’ve got your basic metrics in hand. Now what? The real magic of accounting metrics lies in comparing performance against prior – and future – periods.
If I told you that company X invoiced £35k of Turnover last month, is that good or bad? Who knows. But if I shared some comparatives … across the last 3 months they had invoiced £20k, £25k, and then £35k, then suddenly the story looks extremely bright. I might then investigate if this is a trend across the last 12 or 24 months, seasonal, or something else.
Comparing your current performance to past periods lets you see if you’re accelerating or stuck in neutral. Accelerating gets you there faster, if you know where you’re trying to be.
The real goldmine comes from benchmarking – comparing your metrics against industry standards or your direct competitors. This is like checking the leaderboard in a competition. Are you pulling ahead, neck-and-neck, or hopelessly behind? Finding relative benchmarking data can be difficult to come by though, and I would say even harder for Start-ups.
So which Accounting Metrics Should You Adopt.
Well … it’s up to you, but I’d start here:
Revenue: the Lifeblood of Your Business
Also called Turnover, Income, sometimes Sales (but I am not so keen on that one depending on your industry).
Revenue, often referred to as the top line, is the total income generated from sales of goods or services. It’s a critical indicator of business activity and market demand.
I wouldn’t get too fancy here and would simply compare current Revenue numbers in a month against previous months, the Budget, and Forecasted projections.
Gross Profit and Gross Profit Margin: Measuring Production Efficiency
Gross profit is the revenue remaining after deducting the cost of goods sold (COGS) or Direct Costs. This accounting metric measures the efficiency of production processes and pricing strategies.
For instance, if you sold a T-Shirt for £20 but it cost you £25 to make, the Gross Profit (or Loss in this case) would identify an immediate floor in this business model.
Small businesses should refer to Gross Profit a lot more than they do.
Deciding which Costs should be attributed as Direct Costs can be more debatable, especially for a SaaS business.
Operating Profit and Operating Profit Margin: The Core of Business Performance
Operating profit, also known as operating income, is the profit earned from core business operations, excluding any non-operational income or expenses. It reflects the company’s ability to generate profit from its primary activities.
Expenses such as monthly or annual Interest Payments made on any loans you have received would be excluded from that Operating Profit figure, for instance.
EBITDA and EBITDA Margin: A Clearer Picture of Operational Performance
Very similar to Operating Profit (especially if you choose to work with Inform Perform!) … EBITDA stands for Earnings Before Interest, Taxes, Depreciation, and Amortisation. This accounting metric provides a clearer picture of operational performance by removing the effects of financing and accounting decisions such as Depreciation and Amortisation.
SaaS businesses should look to adopt EBITDA within their accounts as this may be used by Investors and Acquirer’s to value your business. Or more specifically they multiply your EBITDA figure by their chosen multiple (often based on industry).
Net Profit Breakdown: Unveiling the Two Distinctions
Net Profit comes in two distinct variations, depending on where you are in the tax calculation process:
- Net Profit – PBT (Profit Before Tax): This shows your profit before the taxman takes his cut. This could be akin to a golfer finishing their round with a decent score, and prior to their scorecard being adjusted for their handicap. To a large degree, the Profit Before Tax is the only result you can control as your Year-End Tax could hinge on a number of different factors, including performance from previous years.
- Net Profit – PAT (Profit After Tax): This is the real deal – your true net profit. It’s what’s left over after all expenses and taxes are paid. Think of it as what’s left in your wallet after your kids have extracted their own pocket money.
Net Current Assets: A Snapshot of Short-Term Financial Health
Net current assets, or working capital, is the difference between Current Assets and Current Liabilities. “Current”, in the Accounting context means anything paid or due to be paid within the next 12 months, and so this accounting metric indicates a company’s short-term financial health and operational efficiency.
Stripping out longer items such as Director Loan Accounts, or an element of a Loan not due to be paid back until after the next 12 months will help you to ascertain the current viability of your business. Trust me, I have had to perform this exercise before and it does paint a far more accurate picture of the status-quo.
Cash in Bank (or in Hand): Measuring Liquidity
Cash in bank or in hand represents the company’s liquid assets readily available for use. It’s a critical measure of liquidity and financial stability.
Not a metric, but always take the current Aged Receivables balance into account when taking a view on the Bank Account; as the two can fluctuate in different directions between months. A low Bank and low Aged Receivables balance could be bad news.
Current Ratio: Assessing Short-Term Financial Health
The Current Ratio is a liquidity ratio that measures a company’s ability to pay short-term obligations with its current assets. So for example, a ratio (or result) of 1 means that you have exactly enough Current Assets (i.e. Bank plus Aged Receivable) to pay your Current Liabilities (i.e. Suppliers, HMRC, Loans due). Furthermore, any value above 1 indicates good short-term financial health because you can pay your Current Liabilities off and still have money left over.
Some may say that a good Current Ratio is 2 or between 1 and 3, but really the target for this accounting metric hugely depends on the industry you work within.
Please note that SaaS businesses will have a lower Current Ratio where customers pay for an annual licence in advance.
Quick Ratio (the Acid Test): A Rigorous Liquidity Check
The quick ratio, or ‘the acid test’, is nearly identical to the Current Ratio above, but this time removes Inventory and Prepayments from the equation; because neither can rapidly converted into cash to pay your bills. This is rarely used in Tech or Design businesses, but would be handy for e-commerce type businesses.
Harsh but fair.
Return on Capital Employed (ROCE): Gauging Efficiency and Profitability
ROCE measures a company’s profitability and efficiency in using its ‘capital’ and is calculated by dividing Operating Profit by Capital Employed (with Capital Employed calculated by subtracting Current Liabilities from Total Assets (i.e. Fixed Assets plus Current Assets)).
A higher ROCE indicates more efficient use of capital.
The ROCE calculation is a good one for Asset intense industry’s such as Manufacturing or Air travel.
Round up
In my experience, mastering these accounting metrics can transform the way you understand and manage your business’s financial health.
Whether you’re preparing for a board report or striving to improve operational efficiency, these metrics provide the insights needed to make informed decisions and drive success. Remember, accounting metrics are just the instruments – the power lies in your interpretation and action – to use to identify trends, set realistic goals, and make data-driven decisions.
This post was written by Christopher Grubb. You can find out more about me here.
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I hope the above has helped.
The role of the Finance Director does not need to be a full-time overhead for someone to be committed and make a difference to your business. My aim is to simplify the financial performance, planning and strategic positioning for SaaS and Tech businesses who just want their world to be uncomplicated and thrive.
Please feel free to message me with any comments or questions. Or find me on LinkedIn here.
