Understanding Financial KPIs (Key Performance Indicators)
What are Key Performance Indicators?
Also referred to as key success indicators (KSIs), Key performance indicators (KPIs) refer to a set of quantifiable measurements used to gauge a company’s overall long-term performance. KPIs specifically help determine a company’s strategic, financial, and operational achievements, especially compared to those of other businesses within the same sector.
KPIs are numeric values that indicate whether your team/company is reaching its targets. KPIs are used by teams and leaders to evaluate the quantifiable measure of performance of business processes and individuals, and it has proven to be a highly effective method. Monitoring metrics help you to evaluate your business performance and make data-driven decisions to grow faster.
There are five main types of KPIs: Business KPIs, Sales KPIs, Marketing KPIs, Project Management KPIs, and Financial KPIs. On this article, we will talk about more on Financial KPIs.
Financial KPI is a measurable value that indicates how well a company is doing regarding generating revenue and profits. Monitoring KPIs shows whether a business is achieving its long-term goals.
Regardless of the size, age, and industry, each and every company needs to be conscious of their financial performance. While accountants deal with all the expenses, income and budgets, the company’s leadership also needs to be informed about important financial measures.
The fastest and most efficient way to keep track of an organization’s business performance is to set up a KPI dashboard that displays financial metrics.
The perfect financial KPI report presents real-time updates on a company’s important financial figures, such as the Operating Cash Flow, the Current Ratio, Breakeven Margin of Safety, etc.
Want to see KPIs in action? See how to create beautiful reports and dashboards in Fathom
Importance of Financial KPIs
Keeping track of the finances is a sure way to determine if you’re on the right track, in terms of your success and sustainability. But the long-term success of your business depends on big-picture thinking, grasping financial KPIs and acting like a CEO.
More importantly, it depends on:
- Having clear goals. You may, for example, have the goal of becoming the leading content marketer in your country.
- Stating measurable goals and crisp objectives. You could mention that you want to achieve “X” amount of revenue in the year.
- Building a strategy to help you achieve these goals and objectives. Like answering critical questions:
- Who are you going to target?
- What is your competitive advantage?
- What services will you provide?
- Listing tactics that form part of your strategy
In helping you strategize like a CEO, aside from helping you measure your daily business performance, KPIs help you:
- Determine whether (or not) you’re on track to reach your financial goals
- Evaluate the success of your strategy based on these key metrics
- Pinpoint areas in your business that may need improvement
- Identify any opportunities and challenges
- Assess whether your customers are happy or not
Popular Financial KPIs
At Libabun Business Agency, Financial KPIs are categorized on Businesses’ Profitability, Activity, Efficiency/Leverage, Asset Usage, Liquidity (Solvency), Coverage(Debt service), Gearing, Cashflow/Cash Position, Growth, and Value. Some of the most important KPIs are:
Operating Cash Flow – this KPI shows the total amount of money generated by a company’s daily business operations. The financial metric hints whether a company can maintain a positive cash flow needed for growth or requires external financing to cope with all the expenses.
Operating cash flow is simply the cash generated by the operating activities of the business. Operating activities include the production, sales and delivery of the company’s product and/or services as well as collecting payment from its customers and making payment to suppliers.
Operating Cash Flow calculation = Earnings Before Interest, Tax, Depn& Amort. – Tax Expenses + (Deferred Taxes – Opening Deferred Taxes) – (Non – cash Working Capital – Opening Non – cash Working Capital) – (Net Interest * (Tax Rate / 100))
Current Ratio – A measure of liquidity, it reflects on an organization’s ability to pay all the financial obligations in one year.
This measure compares the totals of the current assets and current liabilities. The higher the current ratio, the greater the ‘cushion’ between current obligations and the business’s ability to pay them. Generally a current ratio of 2 or more is an indicator of good short-term financial strength. In other words, the current assets of the business should be at least double the current liabilities.
Current Ratio = Total Current Assets / Total Current Liabilities
Quick Ratio – The Quick Ratio or Acid-test ratio measures the availability of assets which can quickly be converted into cash to cover current liabilities. Inventory and other less liquid current assets are excluded from this calculation. The Quick Ratio is a measure of the ability to pay short-term creditors immediately from liquid assets.
The Quick Ratio gives a more accurate overview of a company’s financial health than the Current Ratio as it ignores liquid assets such as inventories.
A quick ratio of 1:1 or more is considered ‘safe’.
Quick Ratio = (Cash & Equivalents + Accounts Receivable) / Total Current Liabilities
Gross Profit Margin – A measure of the proportion of revenue that is left after deducting all costs directly related to the sales. The gross profit serves as the source for paying operating expenses. This metric is a great indicator of a company’s financial health, indicating whether a business is capable of paying its operating expenses while having funds left for growth.
Usually, organisations have a relatively stable Gross Profit Margin figure, unless they’ve done some drastic changes affecting the production costs or undergone a change in the pricing policies.
The gross profit margin can be further improved by improving price, volume and cost of sales management.
Gross Profit Margin = Gross Profit / Revenue * 100
Asset Turnover-A measure of how effectively the business has used its assets to generate revenue. Ways to improve this metric include increasing sales using the same asset base, using capital more efficiently, and/or improve cash management by reducing inventory and receivables.
Asset Turnover = Annualised Revenue / Total Assets
Breakeven Point (BEP) – The BEP represents the sales amount ($) that is required to cover Fixed and Variable costs of the business. At the BEP, Operating Profit is equal to zero.
Breakeven Point (BEP) = Fixed Costs / (1 – (Variable Costs / Revenue))
Breakeven Margin of Safety– The breakeven safety margin represents the gap between the actual revenue level and the breakeven point. In other words, the amount by which revenue can drop before losses begin to be incurred. The higher the margin of safety, the lower the risk of incurring losses.
Breakeven Margin of Safety = Revenue – Breakeven Point
Revenue Growth – A measure of the percentage change in revenue for the period. It is an increase in your company’s sales, usually compared to your previous quarters’ revenue performance. It helps you find out if you’re on the right track as a business in terms of financial growth. Management should ensure that revenues increase at rates higher than general economic growth rates (ie. inflation).
Revenue Growth = (Revenue – Prior Revenue) / Prior Revenue * 100
Expense-to-Revenue Ratio– A measure of how efficiently the business is conducting its operations. While growing revenues, management need to monitor the change in expenses. A significant rise in the expense-to-revenue ratio may indicate the eroding of margins and should prompt action.
Expense-to-Revenue Ratio = (Cost of Sales + Expenses) / Revenue * 100
Fixed Asset Turnover – A measure of how effectively the business has used its fixed assets to generate revenue. Ways to improve this metric include using fixed assets more efficiently and/or selling-off any unused fixed assets.
Fixed Asset Turnover = Annualised Revenue / Fixed Assets
Free Cash Flow – Free cash flow is the cash generated by the business, after paying its expenses and investing for future growth. It is the cash left after subtracting capital expenditures from operating cash flow. The term “free cash flow” is used because this cash is free to be paid back to the suppliers of capital.
Free Cash Flow = Operating Cash Flow – (Total Non – Current Assets – Opening Total Non – Current Assets + Depreciation + Depreciation &Amortisation)
Gross Margin Return on Inventory – A measure of the average amount that the inventory returns above its cost. GMROI assists to monitor the investment in inventory and the resulting gross margin earned by this investment. A result higher than 100% indicates that the business is selling its products for more than what it costs to acquire.
Gross Margin Return on Inventory = Annualised Gross Profit / ((Inventory + Opening Inventory) / 2) * 100
Gross Profit Growth – A measure of the percentage change in gross profit for the period.
Gross Profit Growth = (Gross Profit – Prior Gross Profit) / Prior Gross Profit * 100
Gross Profit Margin – A measure of the proportion of revenue that is left after deducting all costs directly related to the sales. The gross profit serves as the source for paying operating expenses. The gross profit margin can be further improved by improving price, volume and cost of sales management.
Gross Profit Margin = Gross Profit / Revenue * 100
Now that you’re familiar with the concept of some of the important financial KPIs, it’s time to set up a financial KPI dashboard.
There are over 50 KPIs available in LibAbun Business that can help you track, measure your company’s financial performance and help your business grow. To know more about these KPIs, please contact us at +4401234712840
Need help with your accountancy? Get an instant quote
Libabun Accountancy is part of Libabun Business Agency. We help Small Businesses grow, automate and thrive.