Small Business Series - A Simple Financial Scorecard For Small Business Health (Ep 4)

Why These Numbers Matter

Hi, this is Stephen McLain of the Finance Leader Podcast. This is bonus episode number 101. I hope everyone is having a great week and that your business is thriving and that you are thriving also. I am enjoying that we are learning this together. Today I am presenting the fourth episode of this limited small business series. Now there is one more episode after this one which will complete the series. My goal is that this series will spark business owners to review their finance and accounting systems, their business models, their ideal customer, their product and service mix, well, really everything, so that they can optimize their business processes, which will in turn help the business owners achieve their goals. In the first three episodes, I talked about revenues and cash flow and what prices you are charging. Now this week I am talking about the five numbers that every business owner should know. Now, if I asked you right now whether your business is financially healthy, what numbers would you use to answer that question? Now many of you can tell me your bank balance or approximately how much you sold last month, but those numbers alone don't tell you whether the business is profitable, financial sustainable, or positioned to grow. Now you don't need 30 KPIs or a complicated dashboard. You need a few numbers that help you make decisions. Again, we've already discussed revenue versus profit, cash flow, and pricing. Today, let's bring those concepts together with the five numbers that every business owner should know.

Revenue And What It Misses

Now the first number you should know, and that is revenue. Revenue is the total amount your business generates from selling products or services before expenses. But this number by itself isn't enough. Now owners should ask, what was the revenue this month? Now, how does that compare with last month? Additionally, how does it compare with the same period last year? Now that is key. Are we ahead or are we behind the plan? Where is the revenue coming from? Now let's go through a very quick example. Let's say monthly revenue increased from $40,000 to $50,000. Now that's a 25% increase. Now that sounds great, but don't celebrate yet. You still need to understand what it costs to generate that additional $10,000. Now revenue tells you how much business you're doing. It doesn't tell you how much money you're making.

Gross Margin Keeps You Honest

Now the second number you should know, and that is gross profit margin. This is one of the most important numbers many small business owners don't monitor closely enough. Now let's go through another example. Gross profit equals revenue minus your direct costs. Now in this example, a direct cost is what you spent to create your products or deliver your services. It does not include the administrative overhead. Now gross profit margin equals gross profit divided by revenue. Let's go through that example. Let's say the revenue is $50,000 and your direct costs are $30,000, which leaves you with a gross profit of $20,000. Now you take that $20,000 divide it by the $50,000, and that gives you a 40% gross margin. Now this percentage matters why. If revenue grows but gross margin falls from 40% to 30%, the business may be selling more while becoming less financially efficient. Now let's tie that principle back to episode three where I talked about what you charge. So pricing and discounts, labor, materials, product mix, and vendor costs can all affect gross margin. Don't just ask whether sales are increasing, ask how much you're keeping from every dollar you sell. Again, how much out of every dollar you sell do you get to keep? This affects future growth, how you can take care of your team and your own personal life.

Net Margin And Real Profit

Now the third number you should know net profit margin. Now move from gross profit to the bottom line. Net profit is what remains after the business pays all of its expenses, which now includes all of your overhead. Now net profit margin is net profit divided by revenue. Now let's go through another example. Let's say the revenue is $50,000 and you have a $5,000 net profit. So net profit margin will be 10%. Now let's put it into owner language. For every $1 of revenue, approximately $10 remains as profit after expenses. Now let's compare two businesses. Business A generates $500,000 in annual revenue with a 5% net margin. So the profit is $25,000. Business B generates $400,000 in revenue with a 15% net margin, so the profit is $60,000. Now business A has more revenue, but business B generates significantly more profit. A bigger business isn't necessarily a better business. Profitable growth is what matters. Now the fourth number you should know, and that is cash available.

Cash Available And Near Term Risk

Now how much cash did your business actually have today? But don't stop at the bank balance. The owner also needs to understand what that cash must cover. Let's go through another example. Let's say you have $30,000 in cash, but over the next several weeks you will owe, let's say, $10,000 in payroll and $5,000 in taxes, and also $4,000 in rent and other overhead, a $3,000 loan payment, and $5,000 in vendor obligations. Now that $30,000 isn't really $30,000 of discretionary cash. This is why I would encourage owners to track the following formula. Let's take the current cash balance, subtract out your upcoming obligations, and then add back any expected customer collections. Eventually, this should evolve into a rolling cash flow forecast. Your bank balance tells you how much cash you have. Your cash forecast tells you how much flexibility you have.

Break Even Point Sets The Floor

Now finally, the fifth number you should know, your break-even point. This is the number I would emphasize most heavily because many small business owners don't know it. Your breakeven point answers, how much do I need to sell before the business begins making money? Suppose the business has approximately $20,000 of monthly fixed cost and a 40% contribution margin. The monthly breakeven revenue would be approximately take the $20,000 divided by the 40%, and that would get you $50,000. That means the business needs roughly $50,000 of monthly revenue before it begins generating operating profit under those assumptions. If your monthly sales goal is $40,000, but your break-even point is $50,000, you have a structural problem. If your break-even point is $50,000 and you're consistently generating $75,000, you have greater financial flexibility. Your sales goal shouldn't simply be the number you hope to achieve.

Build Your Scorecard And Take Action

Now for action today, I want you to create a small business financial scorecard for your business, where you consistently track these five numbers to gauge the health of your business. Now let's review very quickly the five numbers. The first one is revenue. Now this is how much you're selling. The next is gross profit margin. Now that is how profitable your products and services are before overhead. The next is net profit margin, which is how much you're actually earning. Next is the cash available, which means this is your immediate financial capacity. And then finally your break-even point. This is the minimum level of business that you need. Now no single number tells the entire story. Revenue might be increasing while margins decline. Profit might look strong while cash deteriorates. Cash might look healthy today while a major obligation is approaching. The numbers become valuable when you look at them together. Now compare those numbers with the prior month. What's getting better? What's getting worse? And where do I need to take action? Now that is the key. Knowing your numbers isn't about becoming an accountant, it's about becoming a better business owner. The numbers don't make the decision for you, they give you the insight to make a better decision.

Final Takeaways And Next Topic

Now for the next episode, I will talk about leadership in your business. The businesses that grow consistently are led by owners who make decisions like CEOs. Have a great week. Continue to know your business so you can grow your business. Take care and thank you.