Financial structure is an indispensable part of a business. There are chances your business will fail if your financial structure is weak. Be it your accounting records, delayed payment or pending invoices, it can weaken financial strength of your business. Therefore, we need to keep every metric of the business under control and under check.
There are various factors that constitute financial metric of your business like cash flow, account payable, account receivable, and direct cost. Without further ado, let’s dive directly into the brief description of those metrics and how it affects your business.
- Cash Flow
Cash flow is the amount that is actually flowing in and out of your bank. The overall management of cash flow indicates financial performance of your business. The key calculation is: the money coming in your business is considered positive and money going out is considered negative. So, the total cash flow is the cash you get minus the cash you pay out. The aim is to keep your business in positive lane. It means the amount you have to pay out should always be less than the amount your receive.
But it sounds similar to profit. No!
Cash flow is not similar to profit.
For instance: suppose you have sold a product, whose payment will be received in 30 days. If you are tabulating profits for this sale, it will be shown as profit as product is being sold, but if you are tabulating cash flow, it will not be considered as cash flow of any type as no cash is involved. It will be considered as cash flow once the payment is done.
- Account Receivable
Account receivable is the amount that is owed to you by your customers. It’s simply is the situation where you sell your products or services to your customers where payment is to be done in future.
Even though it makes more sense that customers pay as soon as they buy products, but unfortunately it doesn’t work like that. Usually services are given and time span (like, 30 days) is given to customers to pay all their invoices.
And as we can figure it out, it doesn’t always happen. There will always be few customers who will try to make payments as late as possible. That’s where account receivable comes in the picture.
In your balance sheet, account receivable is shown as asset. Why?
Because, account receivable is the fund that is to be collected in the future. It is considered a good thing in your balance sheet because, suppose you are going through financial crisis then you can rely upon account receivable.
Tracking account receivable is critical to staying stable in the business.
In order maintain a positive cash flow, we need to lower account receivable.
- Account Payable
Account receivable is the total amount that is to be paid by you but is yet not paid.Suppose, few bills have arrived. Do you pay them all immediately in one go? No. There are some bills you keep on hold before you pay them, may be because you don’t have enough funds or flexibility at that time, or you are waiting for your customers to clear their bills first. In short, some bills get on hold. Such amounts are called Account Payable. As it is seen as short term debt to be paid in the future, therefore, it is seen as liability in your balance sheet. Ideally, your balance sheet must be organised and the account payables must be added to it. It doesn’t mean you got the payment, but it will help you maintain a list of customers who you owe and what is the amount in your liabilities are.
It is important for you to manage your liabilities because as your business will grow, the places from where you receive bills will increase. If you cannot manage your debts, then you can find yourself in financially crippling situation.
- Direct Cost
It is also known as “cost-of-good-sold.” Direct cost simply indicates the cost of materials that was used in manufacturing products and also potential labor cost. This doesn’t include marketing expenses, insurances, and other expenditure.
In simple terms it indicates cost of manufacturing or creating the products that company sells.
For example: if your business is about selling coffee, direct cost will include cost of milk and coffee. It will not include the rent, marketing cost, the cost of buying furnitures, setting up ambiance and etc.
Deciding what factors to include in calculation of direct cost varies from business to business. For example: in software solution provider companies labor cost will be covered into indirect cost whereas in mechanical companies like car/motorcycle manufacturing companies labor cost will be included in direct cost.
It is very important to consider this metric into your financial structure of your business as you direct cost determines the cost of your service or products. Lower direct cost implies low amount is invested in delivering your products. Lower direct costs means that your entire process of manufacturing and delivering is done efficiently.
- Operating Margin
Profit is one of the most important metric of any business. Beside from monitoring your cash, it is really important to track whether your company is making more money than expending is really important.
When your earnings are represented in percentage of total sale, it is called margins. In simple words, margins are profit ratios.
Let us assume, we have two companies. One A and other B. Lets us assume that company A had sales of $3.5 million and its profit was $250,000, whereas company B had sales of $5 million and profit of $300,000.
In terms of profit company B will look bigger but if you consider profit margins, then A is more efficient as it has made more than seven cents for every dollar sale. The profit margin of B is six cents per dollar sale.
Higher operating margins are better. Growing operating margins implies that the sale of company is growing.
In simple words: operating margin measures of your profitability and operational efficiency of your business.
Please extend our blog with your comments, suggestion or advice. We would love to hear what you have to say. If you have any suggestion or struggling with any concept of key metric, let us know in comment section and we will try to address your query in detail. But above all, ensure that you are fully prepared to take effective financial road to success and in case of any second thought, remember us.
Thank You.Tags: accounting, cash flow, direct cost, Finance, payable, profit, receivable