Measure performance and set targets

Measurement of financial performance is an important part of running a growing business. Many businesses fail because of poor financial management or planning.

Financial performance review

A financial performance review can help you examine your business goals and plan effectively for improving the business. When carrying out a financial review of your business, you should consider:

• Cashflow - this is the balance of all of the money flowing in and out of your business. You should regularly review and update your forecast. See cashflow management.
• Working capital - have your requirements changed? If so, try to determine why and assess how this compares to the industry standard.
• Cost base - keep your costs under review. Make sure that your costs are covered in your sale price - but don't expect your customers to pay for any business inefficiencies. See how to price your product or service.
• Borrowing - what is the position of any overdrafts or loans? Can you use cheaper or more appropriate forms of finance? See borrowing finance for your business.
• Growth - do you have plans in place to adapt your financing to accommodate your business' changing needs and growth? Read more on financing growth.

Financial performance measures

One of the most important financial areas you should review is your profitability. This is your capacity to make a profit, ie generate revenue that exceeds your overall expenditure (all costs, taxes and expenses). Most growing businesses ultimately target increased profits, so it's important to know how to analyse your profitability ratios.

Profitability ratios

Profitability ratios typically fall under two broad categories: margins and returns. Most common profitability ratios are:

• Gross profit margin - how much money is made after direct costs of sales have been taken into account, or the contribution as it is also known.
• Operating expenses margin - this lies between the gross and net measures of profitability. Overheads are taken into account, but interest and tax payments are not. For this reason, it is also known as the EBIT (earnings before interest and taxes) margin.
• Net profit margin - this is a much narrower measure of profits, as it takes all costs into account, not just direct ones. All overheads, as well as interest and tax payments, are included in the profit calculation.
• Return on capital employed - this calculates net profit as a percentage of the total capital employed in a business. This allows you to see how well the money invested in your business is performing compared with other investments you could make with it, like putting it in the bank.

Accounting ratios to measure performance

As well as measuring profit, you should consider other standard financial ratios to help you to analyse your business' performance. These ratios look at:

• liquidity - assessing your ability to meet your short-term financial obligations
• solvency - measuring long-term debt against assets and equity to determine financial stability
• efficiency - measuring things like stock turnover to determine how well you are using your business assets

Measuring these ratios against industry averages, previous years and competitors can help you identify problems and issues within your business. See how to use accounting ratios to assess business performance.