Have you ever been determined to eat right and get in shape? Do you recall the pure joy you felt every time you tracked and achieved your weekly fitness goals? Hold that thought.
That’s precisely how you will feel when setting and tracking your financial KPIs for your business. Tracking your KPIs can help you set short and long-term goals, showing you all those areas in which you’re doing a great job and those in which you may need to pull up your socks, thereby catalyzing overall growth.
What is a financial KPI?
Before we get into what financial KPIs you should be tracking, we must understand what they are and what they indicate for a business. A financial KPI, or Key Performance Indicator, is a quantifiable metric organizations use to evaluate their financial performance and progress toward strategic objectives. These indicators provide a peek into a company’s financial health, efficiency, and effectiveness in achieving its goals. Tracking financial KPIs enables companies to monitor their financial health, make informed decisions, and continually improve their processes toward achieving their goals.
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Why is it important?
Measuring and tracking key performance indicators is highly recommended for a small business in a competitive market. These KPIs help you to set achievable goals and monitor your growth as you go along. KPIs aren’t just for big-picture analysis; they’re invaluable on a micro-level, too. Tracking can help you notice behavioral patterns such as peak sales days or the impact of business closure due to unforeseeable circumstances or public holidays and their effect on revenue. Ultimately, the goal of leveraging financial KPIs is to improve business performance. By prioritizing specific important financial metrics based on your goals, strategy decisions become more apparent, supporting the continuous enhancement of business operations.
6 Financial KPIs you must be tracking:
To help you better understand these complicated concepts, we’ve decided to break them down by drawing parallels to your real-life mundane tasks.
Gross Profit Margin
Imagine you own a bakery. The cost of all the raw ingredients you need to bake your delicious cakes and cookies, such as flour, sugar, and chocolate chips, is your “cost of goods sold” (COGS). The money you get from selling those cookies to your enthusiastic customers is your “net sales.” but how do you know whether your business is performing well and profitable?
Let us tell you. To gauge and see how well your cookie business is doing, you calculate your “gross profit margin.” Here’s how it works: you subtract the cost of ingredients from the money you made selling cookies to find your “gross profit.” Then, divide that gross profit by the total sales and multiply by 100% to get your gross profit margin.
This helps you understand how efficiently your business runs compared to other companies.
FORMULA: Gross profit margin = (revenue – cost of sales) / revenue x 100
Accounts Payable Turnover
Imagine you’re running a small grocery store. The accounts payable turnover is like tracking how quickly you pay your suppliers for the groceries you buy to stock your shelves.
It’s a way to see if you’re managing your cash flow well.
FORMULA: Accounts payable turnover = Net Credit Purchases / Average accounts payable balance for the period
This number tells you how many times you’ve paid off your average debt to suppliers in that period. The higher the number, the faster you’re paying them back. This is a crucial KPI to track to ensure timely payments and long-term successful relationships with your suppliers.
Net Profit Margin
Consider your finances a household chore: budgeting after you’ve accounted for all your monthly shopping. Net profit margin is like looking at how much money you have left after you’ve paid all your bills and expenses for the month. Just like in your household, where you’d love to have some money left over for recreational purposes after paying your bills, in business, a healthy net profit margin shows how efficiently a company is managing its expenses and generating profit from its revenue.
FORMULA: Net profit margin = net profit/revenue x 100
Accounts Receivable Turnover
We’ve all had those days when we’ve lent friends and family members some money. Tracking these transactions, or friendly debts, and ensuring you receive the money you’ve given away in timely installments becomes quite an important task. You want to know how efficiently you’re getting that money back. Like in this scenario, you’d like your money back on time. The same applies to your business, and that is nothing but your accounts receivable turnover. A higher accounts receivable turnover indicates that you’re collecting money from all the people you might have lent your money to promptly, which, as one can quickly tell, is a positive sign for your company’s financial health.
FORMULA: Accounts receivable turnover ratio = net credit sales / average accounts receivable
Debt to Equity Ratio
Picture this: you’re planning a movie night and want to ensure your snack count is balanced, neither too much nor too little. All you want is to enjoy your binge session without feeling overwhelmed by the amount of popcorn or soda you’ve gathered.
In this scenario, consider all your snacks as your debt and all the comfy seating you’ve invested in to enhance your movie-watching experience as your shareholders’ equity. To calculate the debt-to-equity ratio for your movie night, you’d divide the total snacks by the total seats and blankets. If you have many more snacks than seating and blankets, you have a high debt-to-equity ratio. A high ratio is okay if your debt contributes to your profit and cash flow.
When it comes to your business, having a lower ratio is better, as this suggests a lower dependence on borrowing and a stronger financial position. Investors may prefer companies with a lower debt/equity ratio as it implies lower financial risk.
FORMULA: Debt-to-equity ratio = total debt / total equity
Return on Sales
Think of the return on sales next. Tracking how efficiently you’re turning your sales revenue into profit is essential.
Let us give you an example, and this time, one that uses math: if you’re selling lemonade and you spend $20 on lemons, cups, and other supplies and $30 on operating expenses like marketing, your total expenses are $50.
If you sell your lemonade for $100, your operating profit is $50 ($100 revenue – $50 expenses). In this case, your return on sales is 50% ($50 profit / $100 revenue x 100%), showing that for every dollar you make selling lemonade, you earn 50 cents in profit.
Similarly, in a business setup, your return on sales is the money you make on every sale. It reveals how efficiently a company converts revenue into profit. ROS provides a clear picture of profitability and performance. A high ROS indicates operational efficiency and healthy profit margins, while a low ROS may signal areas needing improvement.
FORMULA: ROS= Operating Profit / Net Sales
Final Thoughts:
Boosting business performance starts with tracking the right metrics. Focusing on these 6 Financial KPIs will give you invaluable insights into your company’s financial health, efficiency, and effectiveness. These indicators provide a roadmap to success, from profitability and liquidity to operational efficiency and risk management. So, if you’re ready to take your business to the next level, start monitoring these KPIs today. With data-driven decisions and strategic insights, you’ll be well-equipped to optimize performance, drive growth, and achieve your business goals with flair.
Want to know more about finance and budgeting? In addition to HR, benefits, recruiting and payroll through its PeopleOps, Escalon’s Essential Business Services include FinOps (CFO services, taxes, bookkeeping and accounting) and Risk (business insurance). Talk to an expert today.
