First and Foremost: What Is a KPI?
KPIs measure a company’s success, with high-level KPIs giving an overall view and lower-level KPIs focusing on individual processes. It’s best to stick to 10 or fewer KPIs. KPIs can focus on financial, customer, operational, or employee metrics and can be leading or lagging indicators. Leading indicators predict future outcomes, while lagging indicators measure past results and help identify trends. Monitoring KPIs helps companies make informed decisions for future success.
The Power of 10: Financial KPIs You Can’t Afford to Ignore
While it’s important for organizations to identify industry-specific KPIs that contribute to their success, there are several financial KPIs that are relevant to most growing businesses. Here are 10 popular financial KPIs that companies should consider monitoring:
1. Gross Profit Margin
This measures the efficiency of a company in converting its product or service into profits, by subtracting the cost of goods sold (COGS) from the revenue generated from product sales. A higher gross profit margin indicates better efficiency.
By keeping an eye on these financial KPIs, businesses can gain valuable insights into their financial health and make informed decisions to drive growth.
2. Operating Profit Margin
Operating profit margin is a key metric that shows how much profit a company earns from its operations, before factoring in taxes and interest. A higher operating profit margin suggests that a company is managing its costs effectively. To calculate this metric, simply deduct the cost of goods sold, operating expenses, and depreciation and amortization from your total sales. By monitoring and improving your operating profit margin, you can boost your company’s financial health and long-term success.
3. Operating Cash Flow
Operating cash flow (OCF) measures the amount of cash that a business generates from its usual operations. This metric helps companies determine their short-term cash availability and identify areas where they can reduce spending. OCF can also highlight potential problems, such as customers delaying or defaulting on payments. Calculating OCF involves using either the direct or indirect method. By keeping a close eye on their OCF and taking steps to improve it, businesses can better manage their cash flow and make informed decisions for sustainable growth.
4. Current Ratio
The current or working capital ratio is a vital metric that gauges a company’s liquidity and its ability to meet its financial commitments. A ratio of 1 or above indicates that a business has more assets than liabilities, which is a healthy sign. However, many companies strive for a ratio of 1.5 to 2, as it provides a more robust financial cushion. Conversely, a ratio below 1 suggests that the business may face financial challenges in the future. By tracking and improving their working capital ratio, businesses can ensure they have the resources to pursue growth opportunities and weather economic uncertainties.
5. Quick Ratio
The quick ratio, also known as the acid test ratio, is a critical metric that assesses a company’s ability to meet its short-term financial obligations. It does so by examining whether the company has sufficient assets to cover its current liabilities. Expressed as a number, a quick ratio of 1.0 indicates that a company has just enough assets to settle its immediate debts. However, if the ratio falls below 1, it suggests that the business may face difficulties in fulfilling its financial commitments. By monitoring and improving their quick ratio, companies can boost their financial resilience and position themselves for long-term success.
6. Return on Assets
Maximizing profits is a key objective for any business, and one way to measure success is by calculating Return on Assets (ROA). This important metric measures how well a company is utilizing its assets to generate profits. A higher ROA indicates better efficiency and profitability. To find ROA, divide the company’s net income by the average total value of assets.
7. Days Payable Outstanding
Days payable outstanding is a metric that shows the average number of days a company takes to pay its creditors and suppliers. It’s an essential factor in managing cash flow, taking advantage of vendor discounts, and building relationships with suppliers.
8. Days Sales Outstanding
The Days Sales Outstanding (DSO) metric measures the average time a company waits to receive payment from its customers. A high DSO implies delayed payments, which can result in cash flow challenges. A low DSO is usually preferable, but economic downturns can cause this number to rise.
9. Cash Runway/Net Burn Rate
Measure the time until your company runs out of cash with cash runway, calculated by your available cash and monthly spending. This crucial metric helps you decide when to cut back spending or seek additional funding. If your cash runway decreases over time, it’s a warning sign that your spending is out of control.
Cash runway is closely linked to burn rate, which measures the monthly expenditure of investor-backed startups that frequently lose money at the beginning of their journey.
10. Budget Variance Rate
Budget variance rate measures the difference between a company’s actual spending or sales and its budgeted amounts. This analysis can be applied to expenses as well as revenue. By comparing the actual and forecasted figures, businesses can identify areas where they need to cut back on spending and areas that require further investment. This analysis helps small business leaders to pinpoint areas of overspending and areas that have exceeded expectations, allowing them to make informed decisions to optimize their budgets.
But now the real question is: How Can Software Help You Set and Track Financial and Operational Metrics?
Using spreadsheets or other manual methods to track basic metrics can quickly become overwhelming. As your business grows and transaction volume increases, it becomes difficult to keep all information up to date, leading to inaccuracies and potential long-term damage. Manually calculating complex metrics, such as financial and operational KPIs, is even more challenging and prone to errors.
Luckily, leading ERP systems like NetSuite can streamline this process by collecting all necessary financial and operational data to calculate any KPIs your business needs to track. With real-time updates and automated report distribution, NetSuite’s dashboards make it easy to stay on top of your metrics and ensure accuracy.
To succeed in today’s dynamic business landscape, it’s vital for growing companies to define clear KPIs and closely monitor a broad spectrum of metrics. Without valuable insights, businesses lack the ability to gauge their progress towards goals and assess their financial wellbeing, leaving them vulnerable to potential missteps.
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