When you are running a business, especially if it is a startup which is just getting up on its legs, it is essential that you track your finances and profit. However, a very important metric that you need to pay attention to is your financial margins. So, right now, you are probably asking yourself: What my financials margins need to be? The answer is a bit more complicated than it seems, and there are some things that you need to know in order to get that answer.
Gross Margin and Net Margin
For starters, it is important that you know that there are two kinds of financial margins. For small businesses, the main focus is the gross profit margin, as it is related to how profitable a particular product that they are making is. Let’s say that your company is selling something for 50 dollars, and the cost of making it is 35 dollars. This means that your gross profit margin is 30% ($50 – $35 = $15, which is then divided by the cost of revenue, which is $50). This is an important metric.
However, when looking at the bigger picture, it’s much less important than net profit margin. Net profit margin basically tells you how profitable your company is. This is due to the fact that it takes total sales into account, deduct business expenses, and then divide the number that you get with your total revenue. So, let’s say that your product has earned you 300,000 dollars, and your expenses cost you 250,000 dollars, then you can tell that your net profit margin is 16%.
The thing about metrics
A very important aspect to keep in mind when it comes to metrics is that they are constantly going to change over time. It all depends both on how well-developed your company is and the current situation when it comes to the market.
You could be in a situation where your business is going at a steady pace, and you are tracking your revenue, but you have forgotten to track the profit margin per customer. So, if your profits start to drop, you will find yourself in big trouble. But, if you have tracked your profit margins and noticed that they are going down, you can do a number of things on time, such as streamlining operations, offering high-margin products, cutting costs, and so on.
There could also be the case that your business is booming. And this is great – you’re getting new customers like you’ve never have before. But if you don’t track how many of them you are losing at the same time, then you’ll be completely blind to the consequences when your profits suddenly start to drop.
If you are a small business, you can tell whether it is healthy by tracking five important metrics: leads that you generate on a weekly or monthly basis, operating reserve, revenue on a weekly or monthly basis, profit on a weekly or monthly basis, and cash on hand. This will help you come up with cognizant decisions about your sales and strategies.
Basically, it is all about knowing which metrics you need to track and at what time. As we have previously ascertained, this often changes, and every development stage of your company requires that you focus on a different set of metrics that will let you know what your business performance truly is.
Positive cash flow
It is very important for your company to have a positive cash flow. This is basically how much cash goes into your business from your usual business operations during a particular period of time. It’s pretty simple – without a positive cash flow, bills will turn into a big issue and you will never be certain whether you have enough money for a particular project or strategy. Remember that there is a difference between cash and profit. A company could be profitable, yet not have a positive cash flow. So, cash flow is a question of survival. When you manage to make it positive, you will enable yourself to come up with proper strategies, without the pressure of the question “Can I afford this?” looming over your head.
Be smart when you borrow
You should only borrow money when you know you are ready to do so. This is only when your business models are proven. It’s a simple and obvious fact – when you borrow money, you have to pay it back on a monthly basis, no matter how well your business is working out. According to a Sydney mortgage broker, it would be wise to have a financial expert who can help you out not only with borrowing but also with other steps that may become useful to you at some point, such as finance restructuring. But, basically, once you have a functional and lucrative business model, you can decide to boldly expand your business via borrowing.
The problem with a lot of companies is that they borrow way too early, and therefore, find themselves in the situation where they can only make short-term decisions limited by their constrained cash flow, instead of making big and long-term decisions that would bring them success. It’s just like we have previously ascertained, when your debt begins to grow, all the steps that you are going to take are going to revolve around survival – that is, making sure that you can pay back the money that you owe, instead of coming up with a long-term strategy to boost your business. So, consult with a financial expert and decide when it is a good idea to borrow money. If you are a startup, it most certainly isn’t. You need to grow enough before you are able to commit yourself to such a deal.
When you start your business, it will all be small and easy, and your margins will be satisfying. This is because you won’t have a huge workforce, and your other overhead expenses will be low too.
However, once your business starts to boom, more cash will come in, and your margins are going to start changing because you will need to hire more staff, sell more products, and move to bigger facilities. At this moment, it becomes essential to track your margins. Your sales may be doing great, but you have to start looking at the bigger picture and calculate your profits and profit margins.