As a small business owner, understanding your company’s financial health is crucial, especially if you’re considering applying for a loan. But with so many numbers to crunch, which ones should you focus on? And just as important, which ones do lenders focus on when evaluating an application for financing?
We’ve compiled a list of the top 10 financial metrics that established businesses need to track in order to be well-prepared to successfully apply for a loan. By tracking these metrics over time, you’ll not only gain insight into your business’s performance but also help lenders easily understand your business, paving the way for a successful loan application when you apply.
Looking through the lenders lens: How financial metrics impact loan decisions
When evaluating a loan application, lenders don’t rely on just one metric to make their decision. Instead, they use multiple metrics to build a complete story of a business’s financial health and loan repayment ability. Each metric tells part of the story, and together they help lenders understand the full financial situation.This ensures that when you do receive a loan, it will feel comfortable to repay and will help your business grow.
Your 10 Must-Measure Metrics
1. Annual Revenue
- What it is: Annual revenue is the total amount of money your business earns from selling goods or services in a year, before subtracting any costs or expenses.
- Why it’s important: Annual revenue is the starting point for understanding your business’s financial performance. It’s the foundation upon which other metrics are built.
- How lenders view it: Lenders use annual revenue to determine the size of loan you might qualify for. There’s a direct link between your revenue and the loan amount you can reasonably handle.
2. Revenue Growth Rate
- What it is: This metric shows how quickly your business is growing by comparing your revenue from one year to the next.
- Why it’s important: Revenue growth rate helps you predict future business performance. For example, if you’ve been growing by 5% each year for the past few years, you can reasonably expect similar growth in the future.
- How lenders view it: Lenders like to see steady, sustainable growth. Very rapid growth, like what many businesses experienced during COVID, can actually be a red flag. Lenders want to make sure your growth is sustainable over the long term.
3. Gross Profit Margin
- What it is: Gross profit margin is the money left over from your revenue after subtracting the direct costs of producing your goods or services. Simply put, it’s gross profit divided by revenue.
- Why it’s important: This is one of the most important metrics because it’s something you can actively control. If your gross profit margin is shrinking, you can take action by finding new suppliers or adjusting your workforce.
- How lenders view it: A healthy gross profit margin shows good business management. If this number is shrinking, it’s a red flag for lenders. It might mean your costs are too high and need to be reduced through cost-cutting measures.
4. Operating Cash Flow
- What it is: Operating cash flow is the money left over after you’ve paid all your regular, or fixed, business expenses (such as rent, utilities, and payroll). It’s the cash you get to keep at work in the business.
- Why it’s important: This number shows how much money your business has available to absorb other expenses, including monthly loan payments.
- How lenders view it: Lenders use operating cash flow to determine how much debt you can comfortably repay. It’s a key factor in deciding whether you can afford to repay a loan.
5. Long-term Debt-to-Equity Ratio
- What it is: This ratio compares the amount of money you’ve borrowed long-term to the amount you, your partners or your investors have put into the business.
- Why it’s important: It shows how much of your business is financed by debt versus owner investment.
- How lenders view it: A lower ratio is better. Lenders want to see that you are highly invested in your company and contributing to its stability.
6. Debt Service Coverage Ratio (DSCR)
- What it is: DSCR compares your operating income to your debt payments. It shows whether you’re generating enough cash to cover your loan payments.
- Why it’s important: This is one of the more crucial metrics for determining if you can afford to take on more debt.
- How lenders view it: A DSCR of 1 means you’re generating just enough cash to make your loan payments. Lenders typically want to see a higher ratio. For SBA loans at Grow America, lenders usually look for a ratio of at least 1.15 to 1.
7. Accounts Receivable Turnover
- Definition: This metric shows how quickly your customers are paying you.
- Why it’s important: Faster payment from customers means more cash on hand for your business. Anything over 60 days is typically considered past due and needs attention.
- How lenders view it: This metric helps lenders understand your cash flow. Even if your books show strong sales, if you’re not collecting payment from your customers in a timely manner, you might struggle to make loan payments.
8. Inventory Turnover Ratio
- What it is: This shows how quickly you’re selling and replacing your inventory.
- Why it’s important: A higher ratio means you’re selling products quickly, which is usually good. A lower ratio might mean you are selling inventory slowly, keeping your cash tied up.
- How lenders view it: This ratio can help forecast how strong of a year you’ll have. A healthy inventory turnover ratio is a green flag for lenders because you are showing good inventory management.
9. Accounts Payable Days Outstanding
- What it is: This metric shows how long it takes you to pay your suppliers. It’s the flip side of accounts receivable, which is how long it takes your customers to pay you.
- Why it’s important: If you’re slow to collect from customers but quick to pay suppliers, you might face cash flow problems.
- How lenders view it: If you can’t pay suppliers on time, lenders worry you might not pay your loan on time either. However, stretching out payments (within reason) isn’t always bad–it can free up cash for other needs.
10. Quick Ratio
- What it is: This compares your assets that can be converted into cash quickly (within 90 days, such as cash and accounts receivable, to your current liabilities, such as upcoming loan payments.
- Why it’s important: It shows whether you have enough current assets to cover your short-term liabilities, including payables such as payroll, taxes, and supplier payments.
- How lenders view it: A ratio below 1 is a huge red flag for lenders. It suggests you might not have enough cash to make your loan payments without borrowing more or scrambling to collect on unpaid invoices.
The bottom line: Track these metrics for better business performance
These ten metrics work together to paint a picture of your business’s financial health. By tracking these numbers regularly, you’ll not only understand your business better but also be well-prepared when it’s time to seek financing. Remember, lenders aren’t just looking at one magic number–they’re looking at the whole story your financials tell. So start crunching those numbers, and watch your business thrive!
And remember, if you feel confident about these metrics and are ready for additional financing, apply with Grow America today!