Never Miss a Beat - Get Updates Direct to Your Inbox
A Guide to Tracking Key Financial Trend Metrics in Your Business
By Quiet Light
“You can’t manage what you don’t measure.”
– Peter Drucker
As an entrepreneur, sound decision making is entirely dependent on your ability to understand the state of your business. Whether you’re in the early stages of bootstrapping or scaling an established company beyond eight figures, it’s essential to have a firm grasp on the metrics that matter most for growth and success.
Despite the critical importance of maintaining a birds eye view, many entrepreneurs fail to track and manage key financial trend metrics within their business. Unfortunately, this often leads to opportunities going unnoticed and threats being overlooked.
In this post, we’ll be discussing the key financial trend metrics that matter the most, as well as how to respond based on the data they uncover.
Key Metrics to Monitor for Monthly Financial Trends
Monthly financial trend metrics provide invaluable insights and empowers effective leadership. A few of the most critical of these to track on a monthly basis include:
- Advertising expense
- Cash flow
Monthly sales is a Key Performance Indicator (KPI) that reveals a business’s product line seasonality and any changes in market share. If a business focuses only on its annual sales and neglects its monthly sales trends, it will be impossible to make accurate forecasts and optimize efficiency throughout the year.
Seasonality is one element that is only possible to understand by looking at a business’s financial data on a monthly accrual basis. Without viewing performance metrics displayed in such a format, there’s no way to truly understand the sales volume that occurred during each month throughout the year.
For eCommerce businesses, understanding seasonality is critical for managing inventory and maintaining financial health.
Identifying Changes in Your Business
Tracking monthly sales trends also allows entrepreneurs to quickly identify changes in their business’s market share. If their monthly sales volume has increased relative to the market, then their market share has increased. Conversely, if their sales volume has decreased compared to the overall market, then owners have reason for concern.
Advertising expense is another KPI that should be tracked on a monthly basis. Instead of focusing on either the annual or lifetime performance of various advertising strategies, business owners can learn the most by looking at monthly changes.
Tracking advertising expenses on a monthly basis can contribute to your overall understanding of seasonality. It can also help you identify changes in market demand. Sales and advertising are two of several elements that play into another essential KPI…
Of all the financial trend metrics, cash flow is perhaps the most important one to track on a monthly basis. This is especially true for eCommerce businesses.
It’s great if your business has high annual earnings. However, that doesn’t mean you should stop paying attention to its monthly cash flow. Even a business that is extremely profitable can run into issues if it fails to manage its monthly cash flow properly. This is a common area of concern for eCommerce businesses.
Without tracking your monthly cash flow, it can be easy to incur expenses that exceed their corresponding revenue for the same time period.
Tracking Cash Flow for eCommerce Businesses
For eCommerce businesses, it’s especially important to pay close attention to cash flow.
Let’s say that you run an eCommerce business and your monthly cash flow suddenly declines—perhaps as a result of increased advertising costs or reduced sales. If you aren’t tracking your monthly cash flow, it can be easy to go ahead and place another order of inventory based on the belief that no changes have taken place within your business.
Once the inventory has been ordered and paid for, you’re left in a challenging situation. You now have more stocked inventory than your sales volume requires and not enough cash to fund your advertising campaigns. Unfortunately, this can lead to a further drop in sales and, in turn, an additional decline in cash flow.
The reason that eCommerce businesses sometimes have challenges managing cash flow is due to the significant capital requirements of carrying inventory and the inherently low margins that many businesses experience.
If you own an eCommerce store that has a low margin, it’s essential to pay close attention to your monthly cash flow in order to effectively manage inventory and all other business expenses. Many experienced entrepreneurs utilize a KPI dashboard so all critical trends are easily accessible at all times.
The Importance of Using Accrual Accounting
To track monthly financial trends, it’s essential to use accrual accounting in your business.
Many entrepreneurs choose to use cash basis accounting, especially when they’re first getting started. Afterall, it is simpler and easier to set up. Most owners can quickly learn how to manage their books themselves using the cash method.
The Issues with Cash Accounting
The main problem with cash accounting is that it makes it impossible to accurately understand your business’s performance on a monthly basis. Because revenue and expenses are recorded based on cash flow and not on when they’re incurred, a monthly cash basis Profit and Loss (P&L) statement provides a false representation of the business’s performance.
For example, if you purchase $100,000 of inventory for your eCommerce business in July but only make $40,000 in sales, your P&L will show a dramatic loss in that month (>60K). If that inventory purchase sustains your business until the end of November, your P&L for the four months following July will show inaccurately high profit margins since the inventory expense was recorded back in July and not in the months when it was actually sold.
The Benefits of Accrual Accounting
The accrual basis of accounting eliminates the appearance of lumpy earnings by attributing revenues and expenses to the months that they are actually incurred rather than when cash exchanges hands. This provides a much more accurate and helpful month-to-month view of the trends within your business.
For example, if you purchase $100,000 of inventory in July, have $40,000 in sales, and your Cost of Goods Sold (CoGS) is only $5,000, you would only record a $5,000 expense instead of $100,000, and your net profit would be $35,000 ($40,000 in sales minus $5,000 in CoGS = $35,000).
The added clarity of accrual accounting provides one additional benefit: more buyers will be interested in acquiring your business if you list it for sale.
What Do Buyers Look For?
Buyers of online businesses don’t just want to know about its current assets, total revenue, and annual net income; they also want to understand what is happening on a monthly basis. Using an accrual basis of accounting is the only way for that to be possible.
This point is so important that it’s typically advisable to switch to accrual accounting before valuing a business.
Setting up accrual accounting procedures usually requires specialized knowledge and experience. Therefore, many online business owners choose to hire a qualified business accountant.
Key Metrics to Monitor for Yearly Financial Trends
While monthly financial trends are crucial for understanding details within your business, yearly financial trends are important for maintaining clarity of the bigger picture and where your business is headed.
A few key metrics to track on an annual basis include:
- Revenue growth
- Profit margins
Every entrepreneur wants their business to be growing, and gross revenue is a critical KPI that reflects whether or not this happening.
Consistent annual revenue growth is generally a clear sign that a business is doing well. Typically, it reflects that the business is succeeding in expanding its market share and attracting more customers.
Additionally, for businesses that are valued based on a revenue multiple, having increasingly high revenue is critical for receiving maximum value. This is especially true for recurring revenue software companies >15M in which revenue growth is an essential variable.
Smart owners also pay close attention to changes to their business’s sales mix. Sales mix is the proportion of each product’s sales relative to the business’s total revenue.
Changes in a business’s sales mix reveals important insights about changes in market demand over time. In order to maximize customer lifetime value, maintain a high customer satisfaction rate, and increase customer retention, businesses should pay close attention to the sales volume and feedback from each product being sold.
In addition to keeping a close eye on money coming in, it’s also important to track expenses.
Tracking changes in various expenses is an important part of implementing effective long-term strategies.Click to tweet
Advertising is one such expense that has evolved greatly over time. As more and more advertisers join different ad platforms, competition and demand have led to increases in ad costs.
If your business relies heavily on Facebook ads, it’s important to closely monitor changes in your ad costs. Doing so can help you identify trends that could threaten your profitability.
For eCommerce businesses, it’s not uncommon for raw material costs to change over time, leading to changes in CoGS. Therefore, being aware of such trends is important for making product launch decisions, negotiating with suppliers, and price adjustments.
The combination of monitoring revenues and expenses reveals one critical financial KPI: Your profit margin.
Of course, your annual earnings is a critical number that reflects how sustainable and financially rewarding your business is to run. Just as revenue growth is a clear sign that your business is getting larger, a growing profit margin means that your business is being run with increasing efficiency.
Maintaining a Long-Term Vision
Some online businesses lose money for the first several months (or longer) before becoming profitable. For example, it’s not uncommon for new Amazon businesses to invest heavily in advertising in order to gain traction. Once their products are established, it is expected that their Advertising Cost of Sales (ACoS) will drop and margins will increase.
Other businesses expect their margins to decrease as their revenue grows beyond a certain point. SaaS companies often see their margins decrease as they invest heavily in customer acquisition activities in an effort to grow.
Impact of Profitability on Valuation
Another reason for the importance of profitability is due to its role in the valuation process. Most online companies are valued based on the earnings multiple method, in which a business’s annual earnings are multiplied by a given number known as the multiple.
In short, annual earnings are a business’s profit after various types of adbacks are “added back” to the business’s profit. Businesses with a high annual earnings growth rate are worth more than those with lower growth rates.
Importance of Monitoring Financial Trend Metrics
The primary advantage of monitoring financial trend metrics can be summed up in one sentence: Understanding your business’s financial trend metrics allows you to quickly identify opportunities and threats in order to respond effectively.
Without tracking the various KPIs that matter most within your business, it’s difficult to make informed decisions. Being in the dark about your business’s finances is like driving a car with a broken speedometer and fuel gauge.
On the other hand, entrepreneurs who have a clear picture of each financial KPI are well positioned to meet their business’s challenges with competent leadership. There are numerous advantages of monitoring financial trend metrics, but of few common ones include being able to:
- Create accurate financial forecasts and long-term strategies
- Effectively manage inventory
- Adjust and optimize ad spend
- Make informed product launch decisions
- Optimize pricing strategies
- Improve revenue growth or profit margins
Most businesses rely on financial forecasts when making investment decisions. By tracking cash flow, revenue, and seasonal trends, it becomes much easier to understand how much money your business will have at any given time.
Being able to predict your cash flow three, six, or nine months from now allows you to know how much money you can invest to launch new product lines or in other growth activities. For example, if you can determine with a high level of confidence that you’ll have an extra $200,000 within the next three months, you can think ahead and make plans for how to best use that money.
Identifying Issues Before They Occur
On the other hand, if your financial projections reveal that your revenue and expenses are on course to deplete your balance sheet within the next three months, it might be wise to hold off on an investment opportunity you were considering.
By creating accurate forecasts, entrepreneurs are able to strategically plan their expenditures and remain financially healthy. For eCommerce businesses, one area in which financial forecasts are essential is inventory management.
Many eCommerce businesses rely on a small margin, so errors in inventory management can be devastating. Failure to accurately predict product demand can easily lead to either running out of inventory or ending up with excess stock.
Obviously, running out of inventory leads to an immediate reduction in sales, revenue, and sometimes, product rankings. Having too much inventory ties up valuable funds and causes cash flow inefficiencies.
Paying attention to seasonal and market trends is invaluable in predicting inventory turnover. Instead of placing inventory orders based on arbitrary notions or rough calculations, entrepreneurs can use data-informed forecasts. These can be based on seasonality and market trends to make sound inventory purchase decisions.
Another common activity that benefits from tracking financial trend metrics is advertising and customer acquisition strategies.
Like inventory management, a sound advertising and marketing strategy requires detailed permanence measurement and trend analysis. What is the ROI of each marketing channel? For an Amazon business, in what months is there a greater or lesser ACoS? What affiliate promotion strategies are most effective for each product line?
Answering these questions allows entrepreneurs to make both short and long-term budgeting decisions and projections.
For eCommerce businesses, managing an effective ad budget is intimately connected to inventory management. Since inventory orders are based on sales KPIs, it’s important to set ad budgets that correspond with inventory levels.
Using Financial Trend Metrics to Make Informed Product Launch Decisions
For eCommerce businesses, there’s a lot to be learned from looking at the performance of various products over time. More than likely, these lessons will be invaluable in helping you make informed product selection decisions for new launches.
If your entire product line experiences a particular seasonal trend, that information may prompt you to launch additional products. By doing so, you can fill in the revenue gaps during your “offseason” months.
Looking at the sales volumes and profit margins of various products will help you to identify commonalities between successful or unsuccessful products. Overall sales volume is usually pretty easy to see. However, understanding the various costs associated with selling each product sometimes takes a little more digging.
Analyzing the monthly and annual trends of your existing product lines can reveal opportunities for additional product ideas. For example, if you sell kitchenware and are able to determine that metal cups consistently have a high margin, it might be wise to consider focusing on launching metal cups with new designs. Or perhaps, you can consider expanding your existing product lines to additional channels.
Since accrual accounting provides much more insight into monthly financial trends, it is the clear winner in the accrual vs. cash accounting debate.
Setting Your Prices
In addition to making better product launch decisions, financial trends can also reveal important data in determining product prices. There are several trends to consider for pricing.
If your raw materials costs are increasing, it may be necessary to increase your prices accordingly. Additionally, rising advertising costs may prompt you to consider a similar bump in prices to maintain profitability.
Sales trends can also dictate pricing decisions. If you’re operating in a market in which there’s a growing demand for higher-end products relative to inexpensive ones, it might be wise to raise your prices and take advantage of the “luxury” market segment. Of course, this often occurs in the opposite direction.
There are limitless additional ways that entrepreneurs can use financial trend metrics to make informed decisions. Almost all of these contribute to one or both of the following goals: to increase revenue or profit margin. At the end of the day, it’s necessary to focus on these two metrics to grow your business and succeed.
As a business owner, there are a variety of tools to help you track your financial trend metrics. Whether it’s a balance sheet template or a well developed software, it’s critical to implement tools and systems for management and optimization.
Tools and Resources for Monitoring Financial Trend Metrics
A well-organized dashboard can provide real-time insight into the state of your business.
Some first-time entrepreneurs start out by tracking finances on a simple spreadsheet. However, most experienced business owners choose to hire a knowledgeable and experienced accountant.
Paid Software Tools
Usually, it’s advisable to use software that integrates with all of your accounts to record revenue or expenses. Of course, these typically include bank accounts, ad accounts, Amazon accounts, or others. Xero is one software that is popular for Amazon businesses and some other online businesses.
When set up correctly, your accounting software should be able to display all important financial data including your current liabilities, current ratio, gross profit, net profit, all expenses, and revenues. This information is invaluable for creating strategic dashboards that reveal the financial trends that allow you to make informed decisions.
Analytics tools such as Google analytics are another great way to understand the variety of web traffic metrics and trends that are crucial for online businesses. There are numerous consultants who specialize in helping businesses optimize using Google analytics, but Google also provides many great resources for learning how to use the platform by yourself.
If you’re considering selling your business, having clean financials also makes it easy to calculate your earnings and apply it to valuation formulas. In fact, presenting clean financials that reveal financial trend metrics is necessary in order to complete an accurate valuation and maximize the value of your business.