… and hello to four metrics that matter!
Don’t forget to grab the worksheet at the end of the post!
The new year is well under way, and there’s lots of talk about business planning and implementation for this year (and beyond!). Before you finalize all those amazing plans for the year, I encourage you to take a few moments to review results from the previous year. By now, you should have those financials available. Now is the perfect time to run a few calculations, gauge your progress, and make any necessary course corrections.
But first, let’s talk about “vanity metrics”. Have you heard this term? Vanity metrics are numbers you track or report that look good to others … but have little bearing on your overall financial health.
One good example is total revenue. If you tell me you reached $2 million in revenue this year, I’d say “congratulations”. Because I know that total revenue is a small piece of your overall financial picture, I would be asking myself how much it cost you to make that $2 million.
If you had $1.9 million in expenses to make $2 million would you still be excited about that total revenue number? That would depend on your industry, and what is standard in profit, but the answer is: probably not.
Total revenue numbers do not help you measure how sustainable your business model is.
INTRODUCING METRICS THAT MATTER
If you want to feel CONFIDENT about the health of your business, track numbers that better reflect its financial health. Here are four critical metrics I track with my clients:
Revenue – Expenses = Profit
This number is found at the bottom of your Profit & Loss Statement (it is also called “Net Income”).
Because it includes all the expenses your business incurred to generate revenue, it’s a far more important figure than revenue alone. Far too many businesses have large revenue numbers, and negative profit!
Compare your profit numbers for the previous 2-5 years to get an accurate understanding of overall growth and profitability. Positive profit (and growth in profit over time) indicates a healthy and sustainable business model.
2. Net Assets
Total Assets – Total Liabilities = Net Assets
You’ll find total assets and total liabilities on your business’ balance sheet. It’s important to calculate net assets; if you looked solely at assets or solely at liabilities, it could be very misleading.
For example, if your business takes out a loan, you receive cash in your bank account. As a result, cash goes up. If you tracked total cash by itself (a seemingly logical metric to track), you would be excited to see your cash balance increase dramatically. However, you would be missing the corresponding liability account which would net to $0 if you were looking at the same picture in the Net Assets calculation.
Over time, the goal is to see net assets increase, as this would indicate the business is producing cash in the long-term.
3. Owner’s Compensation
Owner Salary + Dividends or Draws = Total Owner Compensation
Owner’s compensation is a key piece to the financial puzzle for small businesses. Most business owners I work with are not paying themselves enough. And most would like to increase their compensation.
I am a big proponent of making your small business work for you, and I believe that owners should be paid well for the work they do. If your business is not producing enough income to pay you a reasonable salary either the business model, the pricing, or other expenses need to be reviewed and changed. Often, it’s a combination of all three!
4. Retained Earnings
Profit – Owner’s Draw = Retained Earnings
Retained earnings is the amount of profit that remains in the business after owner’s draws are taken.
This figure shows up in the equity section of your balance sheet at the end of the fiscal year. If negative, you had a loss in your business (and the business is actually sucking resources from shareholders, the owners, or other business resources). A retained earnings number that is positive – especially one that is continually positive and growing – indicates a business on positive trajectory.
READY TO START TRACKING?
To help you measure these metrics, I have created a custom spreadsheet to track your metrics that matter and help you assess the financial progress of your business. I encourage you to take just a couple of minutes to plug in the data. The resulting information could be critical to your business!