A weathervane points to which way the wind is blowing. And when it comes to running a company, key performance indicators (KPIs) signal which way the money is flowing.
To make smart business decisions, you need to understand your numbers—you require a barometer that indicates where you are succeeding or coming up short. This financial visibility enables you to direct your attention to the areas of your business that matter most while making the necessary adjustments and internal optimizations to drive growth.
So, what are the most important financial KPIs? Let’s discuss.
What Are KPIs
As the name suggests, key performance indicators are important metrics that a business can use to track, measure, and analyze its financial performance and overall health.
But KPIs are not only useful on a macro business level—they are also a valuable way that you can set specific and measurable internal goals for employees. Tim Clairmont, CEO of Clear Financial Partners, writes:
“Focusing on a few simple KPIs also creates a common goal for your firm. Your employees can adopt the common language and an easy understanding of what you want done. Sure, they know you want the business to make more money and/or help more people. But by getting simpler and more specific, you do not force them to guess and make assumptions.”
For these metrics to be actionable, they should be set, discussed, measured, and analyzed internally on a regular basis. Armed with this knowledge, you can make the changes needed to reach critical strategic objectives.
Financial Statement Analysis and KPIs
So, how do you discover what your KPI numbers and rates are?
The vast majority of the most critical financial KPIs can be discovered via financial statement analysis. This process involves reviewing your company’s financial statements and the data therein. And for this, there are three integral financial statements that you need to track:
- P&L sheet – Also known as the income statement, this document gauges the company’s profitability, showing the net income or loss over a specified period of time. It is broken down into three categories:
- Revenue
- Expenses
- Profit or loss
- Balance sheet – This demonstrates what a company is worth at any given point in time, by breaking down its assets, liabilities, and shareholder’s equity.
- Cash flow statement – This shows how much money is flowing into and out of the business, as well as cash on hand.
These documents serve as the backbone of both your KPI analysis as well as your financial planning and analysis efforts. And as Louis Mosca, COO of American Management Services notes, they should be leveraged for analysis on a frequent basis:
“Responsible owners complete a financial analysis 10-to-20 days after the end of the month. This is called a post-mortem. A flash report, done weekly, gives some semblance of how the business operates in real-time.”
Financial KPIs That Make an Impact
So, what are the financial KPIs you should concentrate on?
The answer to that partly depends on your industry and business goals. There are KPIs that fall under several categories, including liquidity, profitability, solvency, efficiency, and valuation. With that in mind, there are a few primary financial KPIs that are relevant to practically every type and size of company:
- Gross Profit Margin – This is a profitability KPI that gauges the percentage of revenue left over after the cost of goods sold (COGS) has been subtracted. It lets you see a product or line item’s profitability without factoring in overhead.
- Gross Profit Margin = (Revenue – Cost of Sales) / Revenue * 100
- Net Profit Margin – This is another profitability ratio that allows you to determine the percentage of revenue and income left over after subtracting COGS, interest, taxes, and operating expenses.
- Net Profit Margin = Net Profit / Revenue * 100
- Operating Cash Flow – This KPI is found on a cash flow statement and lets you see your total money generated by your company’s daily business operations. If operating cash flow is positive, that means you have enough funds to grow your operation. On the other hand, if cash flow is negative, you will require internal changes or additional financing to maintain your ongoing operations.
- Working Capital – The cash on hand that is immediately available is known as your working capital. This KPI gauges whether your company currently has enough available assets to oblige your short-term financial obligations.
- Working Capital = Current Assets – Current Liabilities
- Current Ratio – The current ratio measures your company’s ability to pay all of its financial obligations in a single year. In other words, it measures your solvency.
- Current Ratio = Current Assets / Current Liabilities
- Quick Ratio (Acid Test Ratio) – Another type of liquidity ratio, the acid test ratio quantifies your company’s ability to cover its near-future liabilities. This is widely considered a more accurate measurement of the company’s total financial health than a current ratio since it also accounts for inventories.
- Quick Ratio = (Cash + Accounts Receivable + Short-Term Investments) / Current Liabilities
- Debt-to-Equity Ratio – This solvency ratio measures how much of your company is financed using equity versus debt. It demonstrates a company’s solvency, profitability, and signals to shareholders how much debt the business has taken on to become profitable.
- Debt-to-Equity Ratio = Total Debt / Total Equity
- Burn Rate – Your burn rate lets you know how much your company is spending on a weekly, monthly, and yearly basis. This allows you to identify whether your current operating costs are sustainable over the long run.
- Burn Rate = (Starting Balance – Ending Balance) / # Months
- Current Accounts Receivable – This measures the total amount of money owed to the business via clients and debtors. It can be used for several calculations including upcoming income, average debtor days, and how long it takes for clients to pay back their debts.
- Current Accounts Payable – This shows how much the business currently owes to banks, creditors, and suppliers. It can be further broken down into granular detail by projects, departments, and divisions.
CFO Hub – Good for Your Financial Health
There are dozens of KPIs you can track to create more visibility around your business’ financial health. To that end, taking the time to regularly gauge these financial metrics against your business strategies will allow you to continually strive for positive progress.
Here at CFO Hub—to champion this phenomenon—we provide outsourced CFO, financial, and accounting solutions to growing businesses. Whether you need financial guidance and reporting, accounting support, or the assistance of a CFO or financial controller, we have the skill, team, and expertise any budding enterprise could leverage to reach new heights.
Interested in learning more? Contact us today.