Knowing the profitability from your decisions can help you make more profitable decisions. In this weeks update we talk about ways to measure the decisions you make in your business and identifying cashflow in different ways to get your business to grow and be more profitable.
Measuring returns on decisions
With interest rates at record lows and starting to head upwards now is a good time for businesses to be capitalising themselves with low-cost quality debt and investing in themselves for growth in the future.
But, as a business owner, how do you know if you made a good decision?
Whether to hire that person, buy that car, that piece of equipment, that property, extra stock or marketing, there are ways to measure and know if the decision you made has a return and is helping your business grow and be more profitable.
Here are three tools and ways as a business owner you can use to measure your decisions.
ROI
ROI stands for Return on Investment and is a way to measure the outcomes from investing in specific projects.
You calculate ROI by dividing the profit you made from an investment by the initial cost, and it is expressed as a percentage.
For example, you spend $500 on marketing and that leads to $1500 in sales and $1000 in profit, to calculate ROI for this project would be 1000/500=200%.
That 200% / double your money is a solid return on your initial $500 investment. This simple ROI calculation shows that in this case the project or marketing campaign is profitable and worth repeating.
It is not only marketing that ROI can apply to, but it can also be used to measure any specific job/project/investment that a business owner makes where there is a clear profit figure and initial cost. It helps to compare different decisions in a similar way by making them all a percentage of profit.
Often leverage can make these decisions more profitable, and that is using finance or capital from a broker like Skyward Financial for Working Capital and growth. For example, you can borrow $1000 instead of using your own $500 which in this example generated twice as much profit (before interest and fees) which can further improve the ROI and cash flow in the business.
ROA
ROA is an acronym for Return on Assets and can be used as an indictor of how well a business is using its assets.
You calculate ROA by dividing net income before tax by your total assets.
For example, your business made $100,000 net profit last year and has $20,000 in assets (current and non-current). To calculate ROA would be 100,000\20,000=5%.
This is telling you that for all the assets in the business, like cars, property, machinery, and cash, you are generating a return of 5%.
Whether or not this result is good or not depends on how you compare yourself to competitors, industry benchmarks and previous years performances in your own business.
Why it is helpful is to know if you are investing in assets that are making your more profitable.
What ROA is telling you is what is your profit from all of the money you have invested. Put another way, if the $20k you have invested in the business is making you 5%, is that good compared to other investment options inside or outside your business?
If you want to grow your business and invest in more assets Skyward Financial offers Asset Finance for a broad range of things including machinery, motor vehicles and property.
ROE
ROE is short for Return on Equity and is an indication of how well you are using equity to make profit.
You calculate ROE by dividing the business net profit before tax by the equity in the business.
For example, you have profit of $200,000 and on the balance sheet it says there is $50,000 in equity, to calculate ROE would be 200,000\50,000=4%.
What ROE tells you is that for the owners of the business, with the equity in the business, how much profit and return is that equity producing. It can help to identify if
The measure of ROE is different for each industry and even stages of business but is another helpful tool to know as a business if the aggregate of your decisions and the build up of equity in the business is generating you a return.
Equity is sometimes used by a business for further investments like in Commercial Property which Skyward Financial can help with.
Of course, these are not the only, or always the best ways to measure your business decisions, they are tools. Sometimes profit and value is created in ways we can’t quite measure, like through culture and relationships, so it is best to think of like these numbers help to tell the story, but are not the whole story.
If you believe an in-depth review of your business and financial performance Let’s Talk about how our Consulting offering could help you get these numbers and make more profitable decisions.
Cash flows in different ways
There are three types of recognisable cash flow within a business - operating, financing, and investing.
We are going to talk through each of these types of cash flow so we understand them as a category and can better identify them as they relate to decisions we make in a business, specifically when we make a decision that will impact cash flow from day-to-day operations, when we get finance or take a loan, and when we invest in assets for the business.
Each of these types of decisions and corresponding cash flows matters in the profitability and ultimately success of a business, and knowing how to track, measure and manage can be the difference between having an average business and a business that is high cash flow and profit.
Cash from financing activities
This is cash generated from the day-to-day operations of a business, the cash flow from the products or services that a business sells.
Measuring the cash flow from operating business activities is an important benchmark to measure the financial performance from the main things a business makes and sells, the core business. If a business can spin up strong operating cash flow then it has more cash to keep running and growing.
At a basic level the (direct) way to gauge operating cash flow is to look at the net result of all the cash coming into and out of a business. What is left over is the direct cash from day-to-day operations. You want to see this as high as possible as it demonstrates the business is thriving.
The best way to track operating cash flow is to make a cash flow statement. Speak to us or your accountant about getting one made for your business.
Cash from financing activities
Cash from financing activities shows a business owner the flows that are used to fund the business. Funding a business can come from two main things, equity, or debt.
On the equity side this is usually the cash that the business owner puts into the business to start it up or recapitalise it during the growth. On the debt side funding comes from a bank or lender and can be for assets or working capital.
For most small businesses funding is mostly often used for working capital. It is useful to know where the cash and financing of a business is coming from and aim to strike a balance between equity and debt.
Skyward Financial helps businesses for all sizes and shapes from one man shops to large corporates raise debt and finance to grow, so Let’s Talk if you think a boost in capital and finance could help your business.
Cash from investing activities
Cash used for investing in the business for physical assets or like selling shares is designated investing cash flow.
This is usually used to measure the amount of cash a business invests in long term assets like property, equipment and machinery that will help the business meet its goals, grow, generate value, and make profit.
Investing in long terms assets for the business is important for growth and measuring it can help a business owner know how much has been invested and could be invested in the future.
Investing cash flow is important to know because is shows where allocation in the business is going for the long term. For example, into property, or assets or machinery that will hopefully generate value and future profit and ROI (see above). Sometimes investing can cause short term cash flow issues within a business but if the right investment decisions are made it should boost the cash flow and profit in the future.
These tools and measurements can help a business owner make better decisions and measure the return on those decisions, which is ultimately what could be the difference between a business the just survives or thrives.