If you are in charge of managing your business’ finances, then you know that forecasting is one of the most important things you do on an annual basis. Without an accurate financial forecast, your business will be unable to plan for the future and will be more likely to fall into a state of financial disarray.
In theory, forecasting is something that should come naturally to business owners of all varieties. At its core, what you are hoping to do is maximize your business’ monthly revenues while simultaneously decreasing your business’ monthly expenses. Any opportunity where the potential revenues outweigh the potential expenses, when adjusted for opportunity cost, is worth pursuing.
In practice, however, financing forecasting is a significantly more difficult process. Even if you are familiar with the principles of financial planning, there is still no doubt that many of the numbers you use are largely speculative. How many sales can your business expect to accrue in the month of September? What will be the total cost of upgrading your equipment? Incorrectly projecting these figures can be detrimental to your business.
Fortunately, there are many things you can do to make these once speculative figures a bit more precise. The use of key performance indicators (KPIs) makes it possible to take a look at past financial data and create an objective forecast for the future. In this article, we will discuss seven of the most important accounting KPIs accounting companies use and how these indicators can help your business plan for the future.
1. Net Profit Margin
Your net profit margin helps you recognize the relationship between revenues and actual profits. Profit margins are useful when forecasting because they help illustrate how much your business will actually earn with each additional revenue stream. They can also help you determine if your business should use a high volume or niche approach to the market. For example, despite the fact that Walmart is the largest retailer in the world, the company operates with a profit margin that is consistently below 3%.
2. Cost of Goods Sold (COGS)
The Cost of Goods Sold (COGS) can be deducted directly from your income statement and will be essential when forecasting your business’ future expenses. COGS can help you determine a product markup that allows you to maximize total profits. Both decreasing COGS and increasing revenues will increase the overall future value of your business.
3. Sales by Region (and other demographics)
In order to develop an effective marketing strategy, you will need to identify which regions are most profitable. When developing a future forecast, you will also need to decide if your highest performing regions will continue to have an advantage. Carefully reviewing regional sales is especially important for eCommerce businesses that do not have a physical storefront. If sales are high in a specific location, this may suggest an opportunity for future expansions (which will be reflected in your forecast).
4. Marginal Tax Rate
For both businesses and individuals, the marginal tax rate you pay will depend on how much money you have actually earned. Businesses with low (or non-existing) profits will generally pay a lower marginal tax. Higher income businesses—when all else is equal—will be expected to pay a higher marginal rate. If your forecast does not effectively address changes in marginal taxation, you may end up overstating your future take-home profits. Depending on how tight your business’ current operations are, this can produce a variety of damaging ripple effects.
5. Customer Lifetime Value (CLV)
Knowing your customer lifetime value—specifically, the average CLV—can help your business predict the net value that each additional customer can provide. Increasing average CLV will be positively reflected in your profit margins, due to the fact that your business can spend less on attracting new customers. This information will be even more useful (especially for small businesses) if you are able to assign a specific CLV to each active customer. CLV will have an impact on your business’ accounting, marketing, and operational structures.
6. Inventory Turnover
Developing an effective inventory will be necessary for any business hoping to outperform its competitors. Your inventory turnover can be defined as “how many times a company has sold and replaced inventory during a given period.” The best inventory practices will involve carefully balancing the objective of always having enough on hand with the objective of minimizing inventory waste. Inventory turnover will be especially relevant for inventories with finite shelf lives (food, beverages, etc.).
7. Employee Turnover Rate (ETR)
When creating a future forecast, your business will need to account for every expense associated with your employees. This means that in addition to their salaries and benefits, your business should account for the cost of recruiting and training your employees. Businesses that have high employee turnover rates (ETR) will typically need to spend much more on recruiting and training. In fact, the Society for Human Resource Management claimed the average cost of hiring an employee is as much as $4,129. Knowing this figure for your business will help you create a much more comprehensive, cost-conscious forecast.
Conclusion
In general, the best future financial forecasts are the ones that are able to account for as many components of your business as possible. Because much of the data in your forecast will be speculative, it helps to have a few key performance indicators available to guide you along the way. The KPIs mentioned in this article—in addition to various others—can help your business create a forecast that is both realistic and useful.
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