There are many financial terms you need to know to manage your business, and monitoring these metrics empowers you to make data-driven decisions, compare yourself against competition, obtain lending and steer your business toward sustainable growth. If you can understand these terms in the context of your company, you can more easily gauge your business’ financial health.
Below, we cover:
- Financial definitions and formulas
- Customer measurements
- Lending formulas
Financial definitions and formulas
Revenue
All income brought in before any expenses are accounted for.
Revenue growth is the lifeblood of any business. Tracking the revenue growth rate over time—like monthly, quarterly or yearly—shows the fluctuations in your overall sales value.
Gross Profit
The money you make from creating your product or providing your service after you subtract the direct costs of production (also known as Cost of Goods Sold or COGS).
Gross Profit = Revenue - Cost of Goods Sold
Gross Profit Margin
Your gross profit expressed as a percentage of your revenue.
Gross Profit Margin (%) = (Gross Profit / Revenue) x 100
The gross profit margin indicates the profitability of your core business activities (like individual products and services). Maintaining a healthy gross profit margin is crucial for covering operating expenses (like salaries, rent and utilities) and reinvesting in growth. Knowing your gross profit margin makes it easier to compare your gross profits with industry averages.
Net Profit
What remains after all types of expenses are accounted for—it’s the money you make after subtracting your Cost of Goods Sold and general expenses (which are both fixed and variable costs).
Net Profit = Gross Profit - General Expenses
Small business owners track net profit to evaluate business performance, identify areas for improvement and optimize profitability. When entrepreneurs say “profit,” net profit is usually the number they’re referring to.
Net Profit Margin
Your net profit expressed as a percentage of your revenue.
Net Profit Margin (%) = (Net Profit / Revenue) x 100
The net profit margin reveals the overall profitability of your business after accounting for all expenses (including operating, interest and tax). This number makes it easier to compare your gross or net profits with industry averages. Monitoring the net profit margin helps you evaluate operational efficiency and identify areas for cost optimization.
Break-even Point
The amount of revenue you need to break even on your expenses—meaning that you’re making enough money to cover the cost of operating your business.
Break-even Point = Fixed Costs / Gross Profit Margin
Cash Flow
Measures the movement of money in and out of a business, ensuring there’s enough liquidity to anticipate and meet financial obligations.
Accounts Receivable
The money customers owe you for goods or services you provided. Tracking AR allows you to monitor the timing and amount of cash inflows and ensure timely payment collection.
Accounts receivable aging is an overview of overdue invoices. This is the first place to look if you are having cash flow problems. The money people owe you cannot be used to operate or grow your business until it is actually collected.
Accounts Payable
The money you owe to suppliers or creditors for goods or services you bought. Monitoring AP allows you to track outgoing payments so you can maintain positive vendor relationships while managing working capital and liquidity.
Inventory Turnover Ratio
Measures how quickly inventory is sold and replaced, which means you can optimize working capital and avoid excess inventory costs.
Inventory Turnover Ratio = Cost of Goods Sold / Average Inventory
Customer measurements
New Customer Growth Rate
How many new clients have you gained each month? This tells you if your marketing strategy is working.
New Customer Growth Rate = New Customers This Month / Total Customers Last Month
Customer Acquisition Cost
The total amount of money a business spends on acquiring new customers over a specified period.
Customer Acquisition Cost = Total Marketing and Sales Expenses / New Customers Acquired
It helps you understand how much you need to invest in sales and marketing to bring in new customers.
Customer Lifetime Value
Compares the cost of acquiring customers to the revenue generated from them over their lifetime, which can guide marketing and sales strategies. How much revenue can you expect from a single customer over the course of their relationship with your business?
Customer Lifetime Value = Average Purchase Value × Average Purchase Frequency × Customer Lifespan
This allows you to understand the long-term value of acquiring a customer and guides decisions related to customer acquisition and retention.
Customer Retention Rate
How many customers stay with your business?
Customer Retention Rate (%) = [(Customers at End - New Customers Acquired)/Customers at Start] x 100
High retention rates indicate satisfied clients who are likely to continue purchasing from you, while low retention rates could indicate issues with product quality, customer service or other factors causing them to shop elsewhere. Are you having to replace customers all the time? It’s cheaper to retain customers than constantly find new ones.
Customer Satisfaction
Track online reviews and social media chatter about your business. You can also ask customers for feedback through surveys.
Customer Satisfaction Score (%) = (Number of Satisfied Customers / Total Number of Survey Responses) x 100
Lending formulas
Working Capital Ratio (also known as Current Ratio)
Look at your balance sheet to measure your company’s short-term financial health or liquidity.
Current assets: Assets that will be converted into cash within a year (including accounts receivable, inventory and cash).
Current liabilities: Debts you owe within a year (including accounts payable, short-term loans, rent, utilities, taxes and payroll).
Working Capital ($) = Current Assets - Current Liabilities
Working Capital Ratio (%) = Current Assets / Current Liabilities
Debt-to-Equity Ratio
Measures how much debt you have compared to assets or equity (owner-contributed funds). A low debt-to-equity ratio suggests that your business has less financial risk because it relies more on equity financing.
Debt-to-Equity Ratio = Total Liabilities / Total Shareholder Equity
Debt Service Coverage Ratio
Measures a business’ available cash flow to repay loans, get new financing and pay dividends.
Debt Service Coverage Ratio = Net Operating Income / Total Debt Service
Context is key
The formulas aren’t as important as the trends they reveal—that’s where you notice patterns and gauge the impact of your decisions over time. The stories your data tells are where the value lies. You might miss opportunities if you don’t pay attention to the trends in your data, but if you track changes, you can foresee problems and have an exact representation of what certain decisions—like tracking what difference hiring a marketing manager made in attracting new customers—did for your business.
For tailored advice and support, make an appointment with an ATB business advisor.
