Is your company financially healthy? Just as an EKG measures your heart's performance, indicating overall health, key financial indicators measure your company's financial well being. These indicators are tools that allow you to summarize your most important financial areas so you can understand how money moves in and out of your organization. The information obtained from each of them is the lifeblood of your organization, and you can think of it as a snapshot of how healthy your company is right now.
Here are six key financial indicators you should become familiar with if you are not already. Most ratios can be easily calculated from data contained on your firm's financial statements.
1. Current Ratio measures your company's ability to pay its liabilities (debt and accounts payable) with its short-term assets (cash, inventory, and receivables). The higher the current ratio, the more capable your company is of paying its obligations.
You can calculate your current ratio by dividing current assets by current liabilities.
The current ratio can provide a snapshot of the efficiency of your company's operating cycle or how well it can turn its products or services into cash.
2. Quick Ratio is another indication of your company's short-term liquidity. It measures your ability to meet short-term obligations with your most liquid assets. Once again, the higher the quick ratio, the better the position of your company.
To calculate quick ratio, subtract inventories from current assets and divide by current liabilities.
This key financial indicator is conservative, compared to the current ratio, because it does not factor in inventory from current assets. Some companies find it difficult to turn inventory into cash, so the quick ratio can more accurately evaluate short-term financial strength.
3. Backlog refers to a build-up of outstanding work, in the form of orders waiting to be filled, financial paperwork needing to be processed, or contracts waiting to be fulfilled. A backlog can have an impact on your company's future earnings if you are unable to meet demand.
A funded backlog refers to a contract for which Congress has appropriated funds, and an unfunded backlog is one which has not been appropriated. While the funded backlog represents probable future revenues, the unfunded backlog may never produce revenue if Congress does not authorize its payment.
4. Gross Margin represents the percent of total revenue your company retains after incurring the direct costs associated with the products and services you provide. The higher this percentage, the more your company retains on each dollar to pay its other costs and obligations.
You can calculate gross margin by subtracting the cost of goods sold or services rendered from revenue, and dividing by revenue to get a percentage.
This indicator represents the proportion of each dollar your company retains as gross profit, which can be put towards general and administrative expenses, interest expenses, and distributions to shareholders.
5. Net Margin compares net income with sales. This indicator sums up in a single figure how effectively you are running your business.
Net margin can be calculated by dividing net profit by revenue.
Net profit margins are generated from all phases of your business, including taxes. A high net margin indicates higher levels of profitability.
6. Labor Utilization refers to how many of your workforce's hours are billable. In a 2,080-hour work year, if your utilization is 1,720 hours, then you have 360 hours spread out over the course of the year that are not billable.
This number indicates a slack that is present in your firm; you have the potential to increase labor up to a 100 percent utilization rate with your current workforce.
How healthy is your company? Are you prepared to face a Pre-Award Survey of Prospective Contractor - Financial Capability? Use the above six financial indicators each month to give your organization a financial EKG so that you can foresee any problems or trends ahead of time.
