Five ways to measure business health

Keep on top of how well your business is performing by monitoring five key indicators.

There’s an old adage in accountancy: turnover is vanity, profit is sanity and cash-flow is reality. It’s a way of saying that there are numerous measures you can apply when measuring the financial health of your business, but it’s often good to have a rounded picture.

Too often, in a lot of smaller businesses, owners see the annual accounts process as a necessity to satisfy HMRC and possibly their bank. For that reason, it can be left to the last minute. In effect, this can often be nine months after the end of a particular accounting period. So by the time they get an insight into how well their company is doing, the information is no longer up to date.

My advice is to talk to your accountant about receiving management accounts on a monthly or quarterly basis. Then, you need to start looking at the following key indicators:

CASH-FLOW

Everyone talks about it, but how many people really understand its importance? The balance of the money flowing in and out of the business needs to be positive and you can only achieve this with accurate, up-to-date forecasting. You can then start to analyse the reasons for any discrepancies between the projections and your real figures.

TURNOVER

Again, here you should be interested in any differences between your projected turnover and the actual figures. If there are variances, it’s worth having a discussion with your accountant and talking through the implications.

GROSS PROFIT

In a nutshell, your gross profit margin is your income, less cost of goods sold. If this figure isn’t high enough, you won’t be able to cover your overheads and make yourself a profit.

OPERATING PROFIT

Your operating profit figure is your gross profit less your overheads, but will exclude tax and interest. If this figure is too low and you haven’t yet taken money out of the business, you may have nothing to show for your endeavours.

NET PROFIT

This is your total income, less all expenses including interest and tax.

With cloud accounting now becoming increasingly common, it’s actually possible to monitor all these critical indicators in real time. This means you can make comparisons to the same period last year and see whether any improvements you’ve made to your business practices have achieved results.