How can you tell if your business is doing well?
Whether you are looking at your own financial reports or another company’s documents, how can you make sense of the financial information to see if a business is doing well?
If you’ve got two or three years of information, the following calculations can help you to get a sense of a business’s general health.
You don’t need to know all of these but picking one or two might be useful checks for you.
1. Gross profit margin (as a percentage)
📝 The maths: ((Revenue – Cost of Goods/Services Sold) ÷ Revenue) x 100
Why we calculate this: gross profit is the real income of the business. Gross profit margins vary greatly from industry to industry. Look for stable or increasing margins over time. Falling margins may suggest rising levels of competition and downward pressure on prices, or an increase in costs directly associated with the product or service.
2. Net profit margin
📝 The maths: Net Profit Margin = Net Profit / Total Revenues
Why we calculate this: Net profit margin is before interest payable and tax / sales revenue. Net profit is the income remaining once overheads (fixed costs such as rent and salaries) have been deducted from gross profits. It is a good measure of the operating efficiency of a business. Like gross margin, look for stable or increasing margins.
3. Return on capital employed
📝 The maths: Net Profit before interest and tax / (Total Assets – Current Liabilities)
Why we calculate this: ROCE shows how effectively the capital employed (owner’s equity and long term loans) are being used to generate profits. Equity investors are particularly interested in this figure. Generally speaking the higher the figure, the better.
4. Break even point as a percentage of turnover
📝 The maths: (Fixed Costs / Gross Profit Margin) / Sales Revenue.
Why we calculate this: the break-even point as a percentage of turnover tells you much about how scalable a business is. A falling figure suggests scalability; a rising trend suggests the opposite.
And there you have it, four quick ways to check the financial health of your startup.