Keeping your business on course: Metrics to monitor and warning signs to recognise

By Craig Reid, Partner

Operating a business without understanding the numbers can be like sailing a ship blindfolded.

While you might be heading on the right course some of the time, it wouldn’t be surprising if you began to drift. Or worse – you might hit an iceberg!

To keep your business on track, it is good to monitor and respond to a set of core metrics.

The trick is to look at these metrics together, so warning signs can be identified and actions can be taken to reverse negative trends.

Businesses might understand the importance of some of their numbers, but do they know all the numbers? Can they join the dots and see the bigger picture?

Gearing: Is a business funded by debt or equity?

Gearing is the metric that highlights whether your business is funded by debt or equity.

While some borrowing can support growth, too much debt can reduce the flexibility of a business and increase risk when market conditions change.

Too much gearing can become a problem when earnings are unpredictable.

However, the real warning sign here is not the debt itself, but debt combined with falling margins or weakened cash flow.

Together they reduce your ability to absorb shocks.

Margins: How much does a business keep from each sale?

Margins indicate whether pricing and cost structures work.

The gross margin shows what is left after direct costs, whereas operating margin shows what remains after overheads.

A key thing to watch out for is margins tightening without any clear explanation.

This rarely points to a short-term issue, but instead to pricing pressure, such as rising supplier costs that have not been accounted for or inefficiencies in delivery.

Businesses need to be wary of a consistent downward trend.

Liquidity ratios: Can a business pay the bills?

Liquidity in the short term is crucial for the survival of a business.

Tracking this metric can help business owners evaluate whether their business can meet obligations and liabilities when they are due.

Healthy businesses, especially ones just starting out, should worry less about profitability, as liquidity is essential to pay bills comfortably.

Where cash flow is consistently tight despite profitability, it is often a warning sign that a business isn’t managing its finances as it should be.

Efficiency: Does a business get the most output from its inputs?

Efficiency ratios show how well your business is using assets and resources.

One of the most expensive ways to fund growth is if customers are taking too long to pay, or stock is sitting on shelves longer than expected.

Cash that should be available to reinvest might be tied up to fund working capital.

A strong business is one that intervenes quickly to correct inefficient use of assets and resources, not relying on them to correct themselves.

What are some red flags to be aware of?

You understand the metrics, now you need to understand the warning signs.

The following might seem obvious, but are often overlooked:

• A reliance on overdrafts or short-term borrowing to cover day-to-day trading, as opposed to genuine investment.
• Margins that keep drifting down over multiple reporting periods.
• Forecasts and budgets that are consistently wrong are a sign of a business that doesn’t understand its own numbers.
• Stock or inventory building up faster than they are sold, leading to cash sitting on the shelf.
• Cash reserves thinning while turnover rises suggest growth isn’t translating into healthy cash flow.
• Debt increasing without an improvement in profitability shows a company is borrowing more to remain in the same place.

In isolation, none of these factors mean you must sound the sirens. However, they can strongly indicate a business is moving in the wrong direction.

Smart business shouldn’t ignore the warning signs, as problems need to be addressed before they spiral out of control.

If your business isn’t following the numbers, or you don’t know how to recognise when something is wrong, it could be time to speak to an account.

We would be happy to have that conversation and help you understand what the numbers mean, allowing your business to progress with greater clarity.

Ignoring the warning signs may result in a crisis, so get in touch to steer your business back on course.