5 Important Financial Metrics Every Business Professional Should Know

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Admission into a Master of Business Administration program isn’t limited to those who obtained their undergraduate degree in business. In fact, many MBA students have a bachelor degree in other fields. If you fall into this latter group, however, you may be wondering how to acquire certain foundational knowledge essential to your success as an MBA student and business professional.

The Washington State University Carson College of Business understands this dilemma, and we are committed accepting talented, quality students. If you are accepted to our school without a bachelor’s in business or having completed similar courses with a 3.0 on a 4.0 GPA scale, you will enroll in our prerequisite foundation courses. The foundation program is designed to fast-track your learning experience and prepare you for our heightened business curriculum.

If you enroll in the Carson College of Business’ online MBA program and are required to take foundation courses, you’ll study several different metrics that are vital to understanding a business’ financial health and future. Below are five important financial metrics every business professional should know.

It’s possible to get an MBA without a bachelor’s degree in business.

1. Accounts Receivable and Accounts Payable

Accounts receivable is the metric that defines the money a company collects for providing goods or services to a customer on credit. A single account receivable is created when a customer purchases from a company without immediately paying.

Accounts receivable has a direct impact on several other company financials. While accounts receivable are technically assets, a company does run the risk of not collecting the full amount or receiving payment on time. For example, an Extended Days Sales Outstanding – the length of time between the delivery of goods and payment collection – creates the risk of negative cash flow, directly affecting accounts payable. Additionally, a significant number of overdue payments increases the burden on accounting departments as they try to collect, leading to reduced productivity. Thus it’s important for businesses to immediately follow up with accounts that have not paid per the service agreement. If, in your future career, you are ever unsure about a customer’s credit worthiness, it is best practice to ask them to pay for their goods and services with a credit card up front or, avoid extending credit (if possible).

While accounts receivable is the money owed to a company, accounts payable is the inverse, detailing the credit owed to others. Accounts payable are the short-term loans for the goods and services a business has received but hasn’t yet paid for.

A good way to ensure a company only pays credible invoices is to use the long-standing three-way match technique. To use this technique, cross check the following documents to ensure every detail matches:

1. Purchase order
2. Receiving report
3. Vendor invoice

Details to cross check:
1. Order date
2. Product ordered
3. Quantity
4. Taxes

After verifying these details on these three documents, enter an invoice into an accounts payable account.

The accuracy of a company’s financial statements also depends heavily on its accounts payable. A data-entry issue or other error could lead the business to over- or underestimate its liabilities. As such, there are certain best practices to abide by:

• Accuracy: Much of the necessary data, including the dates expenses are incurred, their due dates and their full values, comes from invoices, service agreements and contracts, purchase orders and receiving reports. This information must be cross-checked to make sure records are correct.

• Timeliness: Missing invoice due dates diminishes a company’s relationship with a vendor and may open the business up to fines and interest payments. If missed payments become a trend, suppliers will likely stop offering credit.

• Prioritization: Some suppliers will provide discounts if a business pays its balance before the due date, but this isn’t always the best financial move. Keep cash flow in mind when deciding whether or not to pay an invoice early.

As indicated above, the timelines associated with accounts payable and receivable have a direct impact on cash flow. If accounts payable aren’t collected on time, a business runs the risk of having too little cash on hand to pay its accounts receivable when they are due. Carefully monitoring these two metrics is essential for the health of the company.

2. Working Capital

Working capital is another indicator of immediate financial health. It measures the difference between current assets and current liabilities. Current assets include those that convert to cash within a year, while liabilities include those that must be paid within a year. In short, working capital is how much cash the business has available for its daily operations. As you might expect, a company should work with positive working capital because this is vital to meeting short-term debts.

Still, the amount of working capital needed depends on industry, customers, suppliers, operations and the age of the business. If a company is rapidly expanding, for example, it will likely need more working capital to accommodate its quick growth. A more stable business with expenses that won’t sharply increase can likely operate on less working capital. You may study more about working capital throughout your studies at The Carson College.

3. Net Profit Margin

Net profit margin divides net profits collected over a particular time frame by the revenue made within that same period. This metric shows how much of every dollar collected turns into profit versus how much is used to cover expenses.

As with working capital, a good net profit margin varies depending on the industry. Net profit margin can also indicate how well a company is able to deliver returns for its shareholders. Wal-Mart, for example, is incredibly profitable but consistently operates on a margin of less than 5 percent. This is, in part, because Wal-Mart is a huge corporation with quick inventory turnover. A much smaller business with slow turnover may have a higher profit margin, but likely doesn’t collect as much revenue as Wal-Mart, so its actual profits and returns to shareholders are much lower.

In addition, a company that prefers to grow with debt instead of equity funding will have a low profit margin. In fact, this metric is subject to a variety of conditions, which you can learn more about as you pursue an MBA.

4. Operating Cash Flow Ratio

The operating cash flow ratio provides a different interpretation of a company’s financial health than other figures on financial statements. It strips away metrics that don’t factor into the main business activities, such as investments, to help you better understand the state of the company’s day-to-day operations, and thus help your company’s strategies.

Specifically, this metric details the amount of cash a business creates through the daily operation of providing goods and services.

As operating cash flow is calculated to reflect the costs of production, depreciation and obligations, certain expenses are left out of the calculation. So, this figure does not include investment costs or long-term capital, which are accrued separately from business operations.

While the optimum operating cash flow ratio varies by industry, a high ratio is generally a value that is greater than 1. This means the business is lucrative and can generate profit for investors; a low cash flow ratio is considered any value less than 1 and means the business isn’t sustainable (the business will need external financing to expand).

A high operating cash flow should please investors.

5. Debt-to-Equity Ratio

While the above metrics are mainly of interest within the business, the debt-to-equity ratio is very important to banks and investors. As the name implies, the ratio compares the company’s total liabilities to its equity financing. Its primary purpose is to determine how aggressively a company uses debt for leveraging. The higher the ratio, the more debt the business has taken on for every dollar of shareholder equity.

Investors and bankers use the debt-to-equity ratio to determine the risk of extending a loan to a company. A higher ratio means a greater risk and implies the business is unable to pay its creditors, possibly making it difficult to get credit. At the same time, however, shareholders will likely prefer a higher ratio as this means they’re more likely to profit.

As with working capital and working capital ratio, an acceptable debt-to-equity ratio depends on the industry. A ratio that works well for a hospitality business might not fit well for retail.

Foundation Courses at the Carson College

The above metrics are just a fraction of the concepts you may study as part of the Carson College’s foundation courses. Our courses in finance, managerial economics and financial and managerial accounting aim to improve your fiscal and critical thinking skills to make you an adept company leader.

In addition to these courses, our foundation track also provides courses on marketing, business law, data analysis and operations management. This structured program aims to ensure you are prepared for our standard MBA coursework. Contact us to learn more today.

Sources:
https://onlinemba.wsu.edu/mba/

http://quickbooks.intuit.com/r/financial-management/cash-flow-tips-a-complete-guide-to-managing-accounts-receivable/

http://www.slate.com/blogs/moneybox/2012/11/26/walmart_wages_they_could_be_higher.html

https://onlinemba.wsu.edu/resources/mba/infographics/digital-job-search/

https://onlinemba.wsu.edu/mba/hospitality-business-management/