Keeping your business on track – Metrics to monitor and warning signs to be aware of

By Sam Bacall, Director

Operating a business without understanding the numbers is like sailing a ship blindfolded.

You might be heading in the right direction some of the time, but it wouldn’t be surprising if you began to drift off course. Or worse… hit an iceberg!

Businesses that stay on course are those who track and respond to a set of core metrics.

The trick is to look at these metrics together, so businesses can see the warning signs and act if they begin to move badly.

Every business understands they need to know their numbers, but do they know all the numbers – can they join the dots and see the bigger picture?

Margins

Margins indicate whether your pricing and cost structures work.

The gross margin shows what is left after direct costs, whereas operating margin shows what remains after overheads.

A key thing to watch out for is margins tightening without any clear explanation.

This rarely points to a short-term issue, but instead a pricing pressure, such as rising supplier costs that have not been accounted for or inefficiencies in delivery.

Businesses need to be wary of a consistent downward trend.

Gearing

Gearing is the metric that highlights whether your business is funded by debt or equity.

While some borrowing can support growth, too much debt can reduce the flexibility of a business and increase risk when market conditions change.

Too much gearing can become a problem when earnings are unpredictable.

However, the real warning sign here is not the debt itself, but debt combined with falling margins or weakened cash flow.

Together they reduce your ability to absorb shocks.

Efficiency

Efficiency ratios show how well you are using assets and resources.

One of the most expensive ways to fund growth is if customers are taking too long to pay, or stock is sitting on shelves longer than expected.

Cash that should be available to reinvest is tied up funding working capital.

A strong business is one that intervenes quickly to correct inefficient use of assets and resources, not relying on them to correct themselves.

Liquidity ratios

Liquidity in the short term is vital for a business’s survival.

This metric can help business owners measure whether their business can meet obligations and liabilities when they are due.

Healthy businesses, especially those starting out, should concern themselves less with profitability, as liquidity is essential to pay bills comfortably.

Where cash flow is consistently tight despite profitability, it is often a red flag that a business isn’t managing its finances correctly.

Key warning signs to watch out for

You understand the metrics, now you need to understand the warning signs.

The following might seem obvious, but are often overlooked:

• A reliance on overdrafts or short-term borrowing to cover day-to-day trading, as opposed to genuine investment
• Margins that keep drifting down over multiple reporting periods
• Forecasts and budgets that are consistently wrong are a sign of a business that doesn’t understand its own numbers
• Stock or inventory building up faster than they are sold, leading to cash sitting on the shelf
• Cash reserves thinning while turnover rises suggest growth isn’t translating into healthy cash flow
• Debt increasing without an improvement in profitability shows a company is borrowing more to remain in the same place

In isolation, while none of these factors means you must sound the sirens, they can indicate a business is moving towards a more precarious position.

Smart business shouldn’t ignore the warning signs, as problems need to be addressed before they grow.

If your business isn’t following the numbers, or you don’t know how to spot when something is wrong, it could be time to speak to an accountant.

We would be happy to have that conversation and help you understand what the numbers are telling you, allowing you to move forward with clarity.

Ignoring the warning signs can result in a crisis – get in touch to steer your business back on course.