Starting a business has become an increasingly attractive venture, particularly for the younger demographic. The advantages are multiple, including self-employment and the liberty to kickstart any type of enterprise. However, initiating a business is far from simple. It requires considerable planning, investment, and effort to attain ownership of a successful business.
Even when businesses have established operations, the task does not wrap up there. Continuous evaluation of metrics and performance data throughout the operational lifespan is pivotal to ensure that the business performance aligns with expectations. This article will discuss three crucial fiscal measures that business owners should be cognizant of.
DEBT-TO-EQUITY RATIO
The debt-to-equity ratio indicates the extent of debt utilized by a company to fund their assets and also shows its relationship to shareholder’s equity. The higher this ratio, the more debt has been used to form the company, as opposed to self-financing and investing.
A high debt-to-equity ratio may not always be detrimental, but it is certainly more precarious for lenders than a lower one. A lower index signifies that growth has been pursued without accumulating excess debt, demonstrating better financial stability. This ratio essentially provides insights on your proficiency in using investor funds and the profitability of your business.
FREE AND OPERATING CASH FLOW
One of the prime objectives of a business is profit generation, thus tracking your cash flow is integral. Operating cash flow ensures sufficient funds are available for the daily functioning of your business and its future continuity. Insufficient operating cash flow could lead to business stagnation or even termination.
Free cash flow is the surplus cash after operating costs, enhancements, and other expenses have been tackled. An abundance of free cash flow signals that your company is poised for growth, debt reduction, and explorations of other expansion opportunities. This marker of a flourishing business can be easily calculated by deducting costs and overheads from total sales.
RETURN ON ASSETS
Return on Assets (ROA) is a performance metric that indicates how effectively a company’s assets are used to generate profit. Your company’s assets should contribute to business growth in some measure. This ratio allows a comparison of your company’s profitability with others. It’s typically expressed as a percentage, calculated by dividing net income by total assets.
ROA can also be viewed as Return on Investment (ROI), highlighting how beneficial your asset investments have been thus far. This proves an accurate method to compare companies within similar industries, albeit with different figures across sectors. Generally, an ROA above 5% is deemed favorable.
These are just a select few of the extensive range of financial metrics and performance indicators available to assess the success of your business over its lifespan. Being cognizant of your numbers is paramount as it’s difficult to operate a successful enterprise without them. Many of these parameters are quite straightforward to calculate, presenting no reason not to utilize them.
