We show you the 15 most relevant financial indicators, so you can take advantage of them when managing any business.
When we hear that a person undertakes, we could say that everyone – or almost everyone – comes to mind words such as: business, profitability, success, money, etc. But you hardly ever hear about something as important and vital to a business as financial indicators.
When a person decides to undertake, he knows that he will have to invest: time, money and above all a lot of effort.
Trusting the success of a project is like throwing a random dice and waiting for the number to come up; But, the good news is that the entrepreneur can always make good plays so that the number of the dice is always in his favor and consequently, the path for the success of his project is flattened to advance quickly and easily without forgetting the most important: to earn income.
If you are seriously thinking about starting a business or you already have your business idea underway but you have no idea about how to ensure that it is on the right track or how to take care of the money you are investing, this post is for you.
Because we teach you the fifteen main financial and management indicators that every entrepreneur must know to have a deep and above all, very detailed vision of finances, sales, production and the business in general in order to make much more assertive and strategic decisions.
So, start taking note!
What is a financial indicator?
An indicator or financial index is something that indicates or reveals a certain reality starting from relating two elements within a whole. In other words – and to put it even simpler – is when you want to know what happens when something “A” is linked to something “B” and what effect the result “C” has on everything you are doing.
In the case of finance, a financial indicator is useful to identify what relationship exists, for example, between sales and business investment. Or, the relationship between profits and accounts payable, and so on.
Image showing a newspaper with different financial variables in the stock market
A financial ratio can help you answer all the questions about one of the most important resources your business idea has: money.
So, taking all of the above into account, we could say that the financial indicator is a sample of your performance. It is a portion within everything that your business implies that serves as a parameter for comparison and planning, because it allows you to measure how close or how far you are from achieving that objective that you set for yourself and based on this, create a plan based on the achievement of said indicator, for the growth and development of your business.
What are financial indicators for?
Taking a look at the financial indicators could be useful to:
Know the stability of the business and know if it is really generating any profit.
Have clear data on the financial health of your business.
They make it easier to determine the strengths and weaknesses of the venture in order to make decisions that allow correcting financial deviations that are out of forecasts or that could generate irreparable losses.
As an entrepreneur, you need to know at all times how the financial health of your business is. Periodically reviewing basic financial ratios is essential to maintain business stability and foresee possible problems in the future, which could seriously compromise your money.
Types of basic financial indicators
Let’s see what are the types of indicators or basic financial ratios that any entrepreneur can use to take care of their money and ensure the success of their business:
Illustration representing fluctuations in the stock market with various financial indices
If you are wondering, how do I know if my business is really profitable? Well, you should know that there are certain mathematical formulas and financial indicators that are made to know exactly that. Some of them are:
1. Gross profit margin
It is one of the most recommended and used calculations by new entrepreneurs, because it allows to determine exactly how much money is being earned from the sale of a product or service. Also, many use this technique, also known as markup, to find out the average price that should be charged for a particular product or service.
Its formula is quite simple:
“Gross profit = total revenue – cost of products or services”
If you want to calculate the percentage margin of gross profit:
“Percentage gross margin = gross profit / total revenue x 100”
2. Operating margin
The operating margin or operating profit is calculated by dividing operating income (gross profit minus operating expenses) by total sales. This financial and management indicator examines the relationship between sales and costs.
3. Net profit margin
The net profit margin is obtained once those expenses that are around the business, fixed and variable, such as rents, bank loans, services (electricity, gas, water, cleaning) are discounted to gross profit.
Its formula is the following:
“Net profit = gross profit – fixed and variable expenses”
4. Net return on investment
This metric that expresses the relationship between the investment and the profit obtained from said investment. It is often used to assess whether the investment is financially worth it.
To calculate the net return on the investment, it is necessary to subtract the value obtained or profit obtained from the total value of the investment, and then divide that total by the value of the investment again.
To express this indicator as a percentage, it must be multiplied by 100.
5. Operational return on investment
It is the ratio of operating profit to total business assets. This metric assesses the operational profitability (use of assets and operational expenses) that has arisen on assets.
6. Return on equity
Evaluates the profitability (before or after taxes) that the entrepreneur has when marketing their products or services.
Financial indicators of liquidity
Illustration showing coins and dollars representing liquidity indicators
One of the priorities of any business is to optimize all the assets it has available; among them, liquidity plays an essential role. Some liquidity indicators that could help to have this asset under control could be:
7. Current Ratio
The current ratio is part of the financial liquidity ratios, interpreting this formula will give us a perspective of the ability to pay the short-term obligations of the business.
To calculate the current ratio we use as a formula the division of current assets with current liabilities.
“Current Ratio = Current Assets / Current Liabilities = N ° times”
It is recommended that the appropriate ratio for current liquidity is between 1.5 and 2 times.
8. Working Capital
This indicator is made to determine the capacity of the enterprise to carry out its activities normally in the short term. It is calculated considering the assets that remain in relation to the short-term liabilities.
When income exceeds expenses, you are facing positive working capital. While negative working capital reflects a problem because it implies a need to increase current assets, that is, there are less earnings and more debts.
9. Acid Test
It is a financial indicator that you can use to know the day-to-day solvency of your venture, that is, it measures your ability to pay in the short term. The formula to calculate it is:
“Acid Test = (Current Assets- Inventories) / Current Liabilities”
If you have a result greater than 1, you will have no problem meeting your short-term obligations. If the result is less than 1, it will indicate that you have problems facing your short-term debts.
10. Cash Ratio
The cash ratio or cash ratio is a financial indicator that measures the ability of the business to quickly meet its obligations in the short term. This, without the need to sell any assets.
To calculate this indicator, only cash is taken into account and divided by current liabilities, which are all commitments that must be fulfilled in the near future. We refer, for example, to short-term bank loans (less than a year) and debts with suppliers.
11. Cash Ratio
With this indicator we will see the proportion of Non-current Assets that are being financed by the entrepreneur’s own resources. The higher this figure is, the better it will be, since long-term investments are financed with the business’s own resources.
The formula is:
“Own funds / Non-current assets.”
Image showing several bills to pay, a calculator and a pen representing the financial indicators of indebtedness
Debt does not have to be a negative thing for an entrepreneur, because it makes it possible for the business to operate with a greater margin of movement during the first years without the need to sacrifice parts of the business.
The important thing is to keep this index under control because obviously, the more debt, the more exposed and compromised the future of the business will be.
Some debt ratios that could be useful for new entrepreneurs could be:
The debt ratio is used to interpret and analyze the proportion of assets in the business that are financed by debt. In addition, it helps to measure and understand risk by dividing your external financing sources (credits and loans); among the internal ones, which are resources, goods and investment.
The formula to calculate the debt of a business is:
“Debt ratio = total liabilities / total assets”
The result can be expressed in decimal or percentage.
13. Short-term debt ratio
In addition to the general formula, we have a financial formula that can also indicate the relationship that exists between the volume of a business’s own funds and the debts they maintain in both the long and the short term.
The formula is:
“Short-term debt = current liabilities / net worth”
14. Long-term debt ratio
To know the long-term debt ratio, simply apply the following formula:
“Long-term debt = non-current liabilities / equity”
15. Working Capital
The working capital indicates the degree of solvency of the business and the capacity it has to pay off its short-term debts. It can be calculated by subtracting current liabilities from current assets or also by adding net worth and non-current liabilities and then subtracting non-current assets.
This financial and management indicator is very important for entrepreneurship enthusiasts because it allows them to know exactly if they have the ability to meet short-term financial commitments, using resources that are within reach.
Stay in control of your business from day one!
You don’t need to be a financial expert to keep track of the money that goes into and out of your business; The important thing is that each euro invested has a purpose in achieving your short and long-term goals.
Start adding, subtracting and dividing today to be sure that your finances are on the right track and if you want to evaluate as much more detail how you can make your business even more profitable, we invite you to read this post in which we show you some financial indicators related to the area of marketing and sales.