Because people tend to place greater emphasis on losses than on gains, entrepreneurs often fail to focus on overall operational strategies by dwelling on singular adverse events. They’re not truly unable to plan for navigation of fluctuating circumstances, but merely limit themselves to reacting to disasters. A superior process deployed by thriving small business owners is reviewing factors connected to general financial health. This places a spotlight on positive systemic behavior rather than responses to avoidable setbacks.
Regardless of business size, operating entirely on gut instinct is destined to result in a continuity of errors. Actions taken have a causal connection to measurable key performance indicators. Business operators are aware of their existence but too frequently insensitive to their features.
Getting Gross Margin
To assure long-term success, entrepreneurs are everlastingly vigilant in judging prices. The key metric for skillful pricing habits is gross profit margin. Simply subtract cost of goods sold from revenue and then divide by revenue. Multiply by 100 to derive gross profit margin percentage.
Costs of goods sold are expenditures directly connected to sales. These are obviously materials or products that are resold to customers. But included in costs of goods sold are direct labor costs. Depending on your industry, costs of goods sold may include amounts paid for subcontractors or special tools needed for projects.
Operations with continuous sales to numerous customers are concerned with gross profit margin over specific periods. A business that conducts jobs lasting weeks for a few customers can uncover gross profit margin for each assignment.
Perceiving Percentage Changes
Gross profit margin must remain sufficiently large enough to cover operating expenses and leave a net profit. This brings about comparison of gross profit and net profit. Your bottom line – the amount of cash left after paying all the bills – is net profit. To determine how fast it’s increasing, take your net profit from a recent period (call it “A”) and net profit from the same period of the prior year (call that “B”). Subtract B from A, and then divide by B. Multiply by 100 to get the percentage increase.
Repeat the calculation of percentage increase for gross profit. Which is rising faster? Ever-higher net profit considered in isolation may result in grandiose self-delusion. If gross profit is not also increasing, the rise in net profit is unsustainable. Net profit can jump upward by cutting expenses. But expense reduction is limited. Ultimately, gross profit increases are the necessary ingredient to higher net profit.
Comprehending Current Ratio
To assess the ability of a business to pay its bills, an analytical measure called the current ratio is useful. Simply divide all current assets by current liabilities. Current assets are cash, accounts receivable, and inventory. Current liabilities are accounts payable and upcoming loan payments as well as collected but not yet remitted sales tax and payroll taxes. A current ratio of less than 1 means you lack sufficient cash (and other assets quickly convertible to cash) for paying your bills. Like all performance indicators, the purpose is to warn of potential problems while they are still solvable.
The Finance Writer 