Financial Performance: Definition, and Ways to Improve
Strong financial performance is key to a company’s long-term success, but it’s a subjective evaluation. There’s no single metric that defines a business’s financial health. Rather, a company’s performance is based on multiple factors, including its revenue, expenses, assets, liabilities, and profitability.
Because financial performance takes a broad view, there are lots of different levers companies can pull to improve it. Here’s a closer look at what financial performance means and strategies to enhance it.
Key Points
• Financial performance indicates a company’s health through revenue, expenses, cash flow, and debts.
• Public companies must submit annual reports to the SEC using Form 10-K.
• Strategies to enhance financial performance include optimizing revenue growth, cutting costs, and improving cash flow.
• Operational efficiency metrics, like inventory turnover and asset utilization, are crucial for financial performance.
• Non-financial metrics, such as customer satisfaction and employee engagement, impact financial health.
What Is Financial Performance?
Financial performance is a broad view of a company’s overall health. It takes multiple dimensions into account, such as revenue, operating expenses, cash flow and debts, rather than looking at any one metric in isolation.
There are lots of stakeholders in a business, from creditors to investors to employees to management. All of these stakeholders have a vested interest in a company’s financial performance and long-term success.
The Securities and Exchange Commission (SEC) requires public companies to share information on their financial performance annually with Form 10-K. This form provides stakeholders with up-to-date data on a company’s finances. It’s accessible to the public in the SEC’s Electronic Data Gathering, Analysis and Retrieval (EDGAR) database.
Core Financial Performance Metrics
There are a variety of metrics you can use to evaluate a company’s financial performance, including profitability ratios, liquidity metrics, and others.
Profitability Ratios (Gross Margin, Net Profit Margin, ROI)
Whether or not a business is profitable is key to its financial performance. Here’s how to value a business in terms of its profitability:
• Gross margin: The gross margin tracks how much revenue a business keeps after subtracting the cost of goods sold (COGS). It’s typically calculated as a percentage. A higher percentage points to profitability, while a low percentage means there’s room for improvement.
• Net profit margin: Similar to the gross margin, the net profit margin measures the amount of revenue a company receives from its sales. However, it additionally subtracts business expenses and taxes to get a clearer picture of net profit.
• Return on investment (ROI): ROI measures how much profit a business makes relative to the cost of an investment. A simple formula for ROI is net profit divided by the cost of the investment. When a business is measuring its financial performance, it might look at the ROI of specific initiatives, such as a marketing campaign, a new product line or the purchase of equipment or technology.
Liquidity Metrics (Current Ratio, Quick Ratio, Cash Flow)
Liquidity metrics measure a company’s ability to pay off short-term obligations with liquid assets. Here are some small business financial ratios to know.
• Current ratio: This term refers to a company’s solvency. It divides assets by liabilities to determine whether a company can cover short-term obligations.
• Quick ratio: This measurement divides a company’s liquid assets by its liabilities. Unlike the current ratio, it doesn’t take inventory into account, but instead focuses on “quick assets” like cash and accounts receivables.
• Cash flow: As the name suggests, cash flow refers to how money moves in and out of a company. A positive cash flow means there’s more money coming in than going out, while a negative cash flow indicates the opposite.
Operational Efficiency (Inventory Turnover, Asset Utilization)
Another important metric when evaluating a company’s financial performance is the efficiency of its operations. Some factors to measure operational efficiency include:
• Inventory turnover: This tracks how much inventory a company sells within a certain time period. Stakeholders may look at how often a company sells out of its entire stock of inventory.
• Asset utilization: From equipment to technology, business assets can be expensive. Asset utilization looks at how efficiently a company is using its assets. It considers the value a company is getting out of its assets vs. the cost of acquiring and maintaining them.
Solvency and Leverage (Debt-to-Equity, Interest Coverage)
Solvency and leverage are key factors when assessing a business’s financial performance. They have to do with a company’s ability to meet debt obligations and how much it relies on debt to maintain operations. Some measures of solvency and leverage include:
• Debt-to-equity ratio: This ratio compares a company’s debt to its equity. A higher ratio can be riskier, since it reveals that a company is financed more by small business loans than by capital.
• Interest coverage ratio: This ratio compares a company’s earnings (before interest and taxes) to the interest charges it must pay on debt. It reveals how easily a business can afford interest expenses.
8 Strategies To Improve Financial Performance
Since financial performance depends on a variety of factors, there are lots of strategies you can use to improve it. Here are some financial performance tips.
1. Revenue Growth Optimization
Optimizing revenue may be an obvious way to boost financial performance, but it doesn’t happen by accident. A business can come up with a revenue growth strategy by analyzing various factors, including pricing, inventory, demand and market conditions. Revenue optimization may come through acquiring new customers, entering new markets, innovating products, diversifying income streams or pursuing other sources of growth.
2. Cost Reduction and Expense Management
Bringing down costs is another way to increase cash flow and improve solvency. As a business owner, you can review all your expenses closely to identify any areas of waste. You might also negotiate with vendors to bring down costs. Reducing expenses can improve profitability, as long as it doesn’t sacrifice product quality or customer experience.
3. Cash Flow Enhancement
Enhancing cash flow can help a business cover its financial obligations and operating costs. A business may analyze its cash flow on a monthly basis to see where cash is coming in and going out of the business. If cash flow is trending negative, consider ways to turn things around, such as cutting costs, boosting revenue or improving accounts receivable collection.
4. Working Capital Improvements
Working capital refers to the money a business has on hand to meet its short-term obligations. You can calculate it by subtracting your business’s current liabilities from its current assets. A negative result indicates financial problems, while a positive result means your business has the means to cover operating costs. At the same time, high working capital isn’t necessarily the goal, as it can suggest that a business isn’t investing its profits back into growth.
5. Strategic Debt Management
Taking on debt can improve a business’s financial performance if it fuels growth. A business might take out a startup business loan, SBA loan, or business line of credit, for example, to hire employees, invest in marketing, or expand to a bigger facility. Equipment financing can be used to purchase equipment. Before borrowing, though, a business should carefully consider a loan’s interest rate, fees, monthly payments, and other terms to make sure it’s affordable. Businesses may also consider debt management strategies like consolidation to simplify repayment or potentially save on interest.
6. Operational Process Improvement
Taking a magnifying glass to your business’s processes can help you make them more efficient and get better results. You may enhance your accounts receivable process by sending invoices more quickly or making it easier for customers to pay. Or you could streamline your supply chain to cut costs and receive products faster. Continuously monitoring your processes can help you improve them, cut out inefficiencies, and boost your business’s bottom line.
7. Data-Driven Financial Decision Making
Financial performance management shouldn’t happen in a vacuum. You can rely on financial analytics and other data to make informed decisions about business processes, growth, and investments. Collecting data before and after a decision can help you evaluate whether it’s working or if you need to change course.
8. Strategic Financial Planning
Strategic financial planning is how your business can achieve its long-term goals. It’s all about defining objectives and making sure they align with your current practices. This planning may be a continuous process that evolves as your business grows.
Implementing Financial Performance Improvements
There are many ways that companies can improve their financial performance, but they must take action on these strategies and measure results as they go. Reducing expenses, managing debt, and making processes more efficient can all benefit a company’s financial well-being.
Before making changes, measure key metrics to see where things stand. Then, you can continue to collect data while you implement new strategies to measure how effective they are.
The Takeaway
There are various ways to enhance business performance, such as cutting waste and leveraging debt strategically. Non-financial metrics, such as customer satisfaction and employee happiness, can also contribute to a company’s bottom line. Taking a multifaceted approach — and measuring results as you go — can help you improve a business’s financial performance and realize its long-term vision.
If you’re seeking financing for your business, SoFi is here to support you. On SoFi’s marketplace, you can shop and compare financing options for your business in minutes.
FAQ
How often should a business evaluate its financial performance?
A business may evaluate its financial performance on a monthly and quarterly basis to stay on top of trends. Most businesses also perform a thorough review annually to compare their financial performance from one year to the next.
Which financial performance metrics are most important for small businesses?
Some of the most important performance metrics for small businesses include gross and net profit margins, operating cash flow, working capital, and debt-to-equity ratio.
How does cost control affect financial performance?
Cost control has the potential to improve financial performance, as it involves a thorough review of your business expenses to find areas to save. Reducing costs — and preventing them from spiraling out of control — can improve cash flow and increase profitability. At the same time, make sure that reducing costs doesn’t diminish the quality of your products or customer experience.
What’s the difference between financial performance and profitability?
Profitability is a specific metric that measures how much money a business makes after subtracting its expenses. Financial performance, on the other hand, is a broad measure of a company’s well-being and includes profitability, cash flow, liabilities and other metrics.
How do non-financial metrics impact overall financial performance?
Non-financial metrics, such as customer satisfaction, employee engagement and operational efficiency, can impact a business’s overall financial performance. Dissatisfied customers, for instance, could be an early signal of profit loss, while a lack of employee engagement could prevent the company from reaching its growth goals.
Photo Credit: iStock/Liubomyr Vorona
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