Contribution margin
The contribution margin is a key measure for evaluating profitability . It is the result of subtracting variable costs from the selling price. This margin, this revenue surplus, determines the amount of funds available to cover fixed costs and generate profit.
Knowing the contribution margin allows us to make informed decisions about pricing, sales volume, and profitability of products or services.
The contribution margin is made up of three fundamental variables: fixed costs, variable costs and profit. Fixed costs are those that do not vary over a certain period of time and do not depend on the volume of production. For example, renting a premises. Variable costs are associated with the production volume. For example, the packaging of a product. Finally, utility is the percentage that we set as a goal to determine benefits.
Analysis of variations
Variance analysis allows you to identify and understand the differences between actual and budgeted results.
This analysis allows Financial Controllers to detect possible deviations and other key indicators in order to take corrective measures.
This analysis gives us the ability to identify and explain the possible reasons behind these variations . This means having a tool that allows us to detect the efficiency and spending of different departments within a company and enables us to review strategies, implement best practices, and avoid those that cause these deviations.
Furthermore, we can identify trends by applying this variance analysis to historical results. This can be very useful when making decisions about suppliers or inventory management.
Free cash flow
When we talk about businesses, free cash flow is the amount of cash available after deducting all operating expenses and investments in assets. To calculate free cash flow, other indicators such as gross operating margin, net profit, and working capital requirements are needed. All of this information provides a valuable piece of data: the company's actual cash on hand.
It's essential to have a financial controller expert to calculate and analyze the results of that calculation . Low free cash flow doesn't necessarily mean bad news. That's why it's crucial to have professionals on board.
Net Cash or cash flow
Net cash, or net cash flow , tells us about a company's ability to generate liquidity. It shows the amount of cash the company can use to pay suppliers, salaries, or cover debts and interest.
Net cash flow provides an objective view of the financial situation, supporting business decisions, evaluating profitability, and facilitating planning and investments. We recently discussed cash flow and its different types in more detail in this article on our Fimax Asesores blog.
ROI (Return on Investment)
Return on investment (ROI) is a fundamental financial metric used to evaluate the profitability of an investment . It is expressed as a percentage and is calculated using the following formula:
ROI = (Return obtained – investment) ÷ investment x 100
ROI allows Financial Controllers to study the effectiveness of investments. If we obtain a positive result it means that we have made money with the investment, although to carry out a complete analysis it is important to take into account aspects such as the average rate of return of the market. On the other hand, if we obtain a negative value, it may mean that we have lost money with the investment and we will have to evaluate the entire process, from the strategy, through decision making and final execution.
Therefore, ROI allows us to evaluate gains and losses, justify our investments, and guide strategic decisions.
EBIT
EBITDA comes from an acronym in English and in Spanish we could translate it as “Earnings before interest, taxes, depreciation and amortization.”
EBITDA shows us the company's profit before taking into account the effects of capital structure, taxes and other financial factors.
Therefore, it is a fundamental metric for understanding a business's profitability and solvency. In other words, it shows how well the company is operating, regardless of tax or financial considerations. Furthermore, this indicator allows us to compare profitability between companies, giving the controller a more comprehensive and competitive perspective.
Capital Budget
A capital budget is a long-term financial plan that details planned capital expenditures for investments in fixed assets, such as machinery, equipment, or property.
Capital budgeting allows us to identify the most profitable investments , assess the associated risks, allocate financial resources, and include these investments within an overall strategy.
In short, this type of budget is crucial for the strategic planning and financial management of a company, as it directly affects its long-term growth capacity and competitiveness.
ROE (Return on equity)
Return on equity, or ROE, is a key financial measure of a company's profitability. It is expressed as the ratio of net income to shareholders' equity. Shareholders' equity is calculated by subtracting total liabilities from total assets.
It is a very attractive indicator for investors , as it measures the financial profitability that the company generates for its shareholders.
Capital Cost
Finally, let's talk about the cost of capital. This indicator allows us to analyze the financial viability of new investment decisions. The cost of capital is a rate of return that represents the minimum return required by investors to compensate for the risk associated with investing in the company.
The capital cost is usually calculated with the following formula:
Ke = Rf + BI (Rm – Rf)
Ke being the capital cost, Rf the risk-free rate and the BI operation (Rm – Rf) the company's premium. This calculation allows us to know the minimum profitability that must be achieved with an investment to cover the needs of the shareholders.
Therefore, the cost of capital allows us to analyze the costs of investment projects, understand the resources used, and minimize the cost of financial resources.
liquidity ratio
The liquidity ratio allows you to assess a company's ability to meet its short-term debts and obligations. To calculate it, you divide the company's current assets by its current liabilities.
Having an expert who analyzes the liquidity ratio will allow us to implement measures that improve these ratios and the management of finances as a whole.
The liquidity ratio helps us make decisions and understand the company's ability to respond to problems that may arise.
These ten terms are key for Financial Controllers. Mastering these concepts provides a solid foundation for strategic financial decision-making and contributes to a company's long-term success.
By understanding and applying these terms effectively, Financial Controllers can play a key role in the management and financial growth of their organizations.
At Fimax Asesores we help you control your company's finances through our Financial Controller service.
Request more information without obligation at info@fimax.com.
