Even the busiest owners can find a few minutes each month to track these four key metrics, which we will review in this article:
1. Gross margin
2. Customer concentration
3. Accounts receivable aging
4. Cash needs
Key metrics to make better decisions for your small business
Each business and industry is unique, so the most important metrics may vary – but these four are critical for most companies, especially for B2B companies but also for some B2C teams.
1. Gross margin
What It Is
Gross margin is the amount of money a company retains after incurring the direct costs associated with producing the goods and services the company provides.
Why It’s Important
By tracking your gross margin on individual products or services, you can figure out where to focus your attention. If one product has a gross margin of 50% and another is just 5%, you might consider allocating more of your time and resources to the higher margin product.
How To Calculate It
(𝑟𝑒𝑣𝑒𝑛𝑢𝑒 − 𝑐𝑜𝑠𝑡 𝑜𝑓 𝑔𝑜𝑜𝑑𝑠 𝑠𝑜𝑙𝑑)/𝑟𝑒𝑣𝑒𝑛𝑢𝑒 × 100
Example
If a product is sold for $100 that cost you $40 to make, that results in a net of $60. Divide that by product revenue ($100) and with the result is a gross margin of 60%.
2. Customer concentration
What It Is
Customer concentration is amount of revenue generated from your customer(s).
Why It’s Important
If your top customer stopped buying from you, would your business go under? That’s what customer concentration can help measure. Ideally, revenue is spread across a variety of customers to decrease risk if one customer leaves.
How much risk and customer concentration you’re comfortable with is up to you and your team to decide, but tracking this metric can help you maximize the impact of diversification and new customer acquisition.
How To Calculate It
𝑎𝑚𝑜𝑢𝑛𝑡 𝑜𝑓 𝑟𝑒𝑣𝑒𝑛𝑢𝑒 𝑓𝑟𝑜𝑚 𝑡𝑜𝑝 𝑐𝑢𝑠𝑡𝑜𝑚𝑒𝑟(𝑠)/𝑡𝑜𝑡𝑎𝑙 𝑟𝑒𝑣𝑒𝑛𝑢𝑒×100
Example
If you earned $90,000 from your top customer last year and your total revenue was $200,000, customer concentration is 45%.
3. Aging of accounts receivable
What It Is
Aging of accounts receivable is a list of current unpaid invoice balances and how long they’ve been outstanding.
Why It’s Important
This metric can be used to discern a company’s ability to recover credit sales during a specific accounting period. Tracking this can help identify customers who have a history of payment issues.
For example, if your aging of accounts receivable report shows that a customer has been slow to pay, maybe they are having financial problems. If that’s the case, you should more closely monitor their payment status for each invoice and pursue the receivables more frequently if necessary.
How To Calculate It
𝑎𝑣𝑒𝑟𝑎𝑔𝑒 𝑎𝑐𝑐𝑜𝑢𝑛𝑡𝑠 𝑟𝑒𝑐𝑒𝑖𝑣𝑎𝑏𝑙𝑒 𝑥 360 𝑑𝑎𝑦/𝑠𝑐𝑟𝑒𝑑𝑖𝑡 𝑠𝑎𝑙𝑒𝑠
Aging of accounts receivable = average accounts receivable x 360 days / credit sales
Example
If you have average accounts receivable of $450,000 from customer A and the total goods you sold to them on credit was $900,000, the accounts receivable aging would be 180 days [($450,000 x 360 days) / $900,000].
4. Cash needs
What It Is
Cash needs are all of the expenses or reimbursements considered in, or required by, a company’s business plan, including funds to cover payment of taxes, assessments, utilities, insurance, and other operating expenses.
Why It’s Important
Running out of cash is the number one reason why new businesses fail. It’s crucial to ensure your business always has enough cash to cover expenses and keep operating in case of an emergency or changes in the economy.
There’s no one-size-fits-all amount for your cash balance to monthly expenses ratio, but the general recommendation is to have enough cash to cover at least three months of expenses. If you don’t have that, you might consider setting up a line of credit or loan that can be relied on if needed.
How To Calculate It
Cash needs = typical monthly operating expenses as compared to balance of cash in your bank account
Add up your typical monthly operating expenses. If you aren’t sure, total all expenses over a certain period (3, 6, 12 months etc.) and then divide by the number of months to get the average. Then look at how much cash you have in the bank to see how many months you could cover if needed.
Example
If typical monthly operating expenses are $4,000 and you currently have $10,000 in the bank, you should be able to cover two and a half months of expenses, even if revenue declines or customers do not pay on time.
Don’t just calculate these metrics each month and forget about it until the next time – track any long-term changes or trends that might provide valuable insights to make better decisions for your business. For example, if your gross margins are declining over time, it could mean you have increasing costs, decreasing sales, or both. Keep an eye on it and look for strategies to improve each metric.
