To make your job a lot easier, you need to understand your business’s financial key performance indicators (KPIs). These quantifiable tools help you measure and track the progress of essential areas. These indicators allow you to get a glimpse of your business’s overall health. Here are financial KPIs that you must track, analyze, and execute as needed:
Liquidity Ratios
This financial indicator will depict your small business’s ability to cover all your debts. Knowing how liquid you are when it comes to your money will help you plan your moves, whether acquiring more assets or demanding client payments. Let’s take a look at two important factors under this category:
• Current Ratio
This is your liquidity measure to gauge if you have the right cash on hand to make a large purchase. Your creditors also rely on this formula to evaluate if they will be able to repay a loan.
Current ratio = currents assets ÷ current liabilities
Your current assets are your cash on hand, as well as all those other assets that you can quickly convert to cash if the need arises. Current liabilities are those things you owe, which you must pay within a year. For best results, make sure your ratio is between 1.5% and 3%. Anything less than one percent is a cause of concern as it signifies you don’t have enough funds trickling in to pay your bills. Keeping an eye out for this ratio will show if you have cashflow problems.
• Quick Ratio
This shows your capability to pay short-term financial liabilities quickly. Because the current ratio gives a one-year leeway, this is a better indicator when it comes to your likelihood of paying debts asap.
Quick ratio = (current assets – inventories) ÷ current liabilities
Some people dub this as the “Acid Test Ratio” because acid tests in science are specifically designed to produce immediate results. This reflects your company’s immediate liquidity and available funds on hand.
Profitability Ratios
These KPIs are metrics used to evaluate your business’s performance regarding generating profit relative to your revenues, operating expenses, balance sheets assets, and equity. It indicates the amount of income your company retains from its original sales, illustrating how well your company utilizes your assets to produce profits. These are:
• Gross Profit Margin
This gives you a percentage value that indicates how much of your revenue is profit after factoring in your expenses like the cost of goods sold. The latter is the direct expenditures related to producing your product. However, it does not include interest payments, operating expenses, or taxes. You compute this by:
Gross profit margin = (revenues – the cost of goods sold) ÷ revenues
Your objective is to ensure that your gross profit margin is bigger than your fixed operating expenses as a business owner. You must have a profit at the end of the day, so you can use the extra funds for paying investor dividends, planning marketing campaigns, and other non-fixed expenditures. Anything below 10% is alarming because you may be facing losses. It is also vital to note that you must match or exceed your industry’s average.
• Net Profit Margin
This KPI tells you what percent of your revenue is your profit. In short, this is your company’s bottom line or the amount of money you have left after paying the bills. This factors in the costs of goods sold plus other expenses.
Net profit margin = (total revenue-total expenses) ÷ total revenue
Examining this metric will help you make projections and set future goals. With this data, you can make benchmarks and assessments of profitability. If you feel like our profit margin is low, you may want to cut back on your budget’s non-essential expenses.
Leverage Ratio
The primary elements to look at with this KPI is your debt, equity, assets, and interest expenses. This measures how much of your company’s assets comes from debt like loans. You can use this to evaluate your company’s mix of operating expenses so you can glean how modifications in output will impact your operating income.
• Debt to Equity Ratio
This KPI is the most well-known financial leverage ratio because it indicates whether your company has been aggressive in financing your growth and expansion through debt. It is important to look at this because your earnings can be volatile because of interest expense.
Debt to equity ratio = total liabilities ÷ total shareholders’ equity
Do note that a ratio that is higher than 2.0 exemplifies that your company is risky. If the company’s interest expense develops too much, it can increase the chances of defaulting loans or bankruptcy.
• Interest Coverage Ratio
This KPI is focused on interest payments as it aims to tell you your business’s ability to service your debts. Looking at your total debt liabilities is not enough. You need this ratio to see the big picture.
Interest coverage ratio = operating income ÷ interest expenses
This exemplifies your capability to make interest payments on your debts. As a rule, a ratio of 3.0 or higher is the goal.
Efficiency Ratio
This indicator showcases how well your business uses all your assets to generate income. It looks at various aspects of your operations, like how long it takes to collect from clients or how fast you convert your inventory to sales. An efficiency ratio is vital because improving this will translate to boosted profitability for your business.
• Inventory Turnover Ratio
This KPI shows how many times your business has sold and replaced inventory during a period. You compute for this amount to see if your business has any excessive stocks in comparison to sales output.
Inventory turnover ratio = cost of goods sold ÷ the average inventory for the same period
Knowing this ratio will help you determine how many days it will take to sell your stocks on hand. A high ratio suggests strong sales, so you have to make sure you have adequate inventory. In contrast, a small ratio means your business is not performing well because inventory is not moving. The longer you hold an item, the higher the holding costs. When you know your business ratio, you can make better decisions regarding your pricing, manufacturing, marketing strategies, and buying new inventory, as all of these elements affect how fast your products are sold.
• Receivable Turnover Ratio
Some refer to this as Debtor’s Turnover Ratio. This is an activity ratio that is a metric for showing how effective your company is when extending credits to clients and collecting those debts.
Receivable turnover ratio = net credit sales ÷average accounts receivables
In general, the higher this ratio, the more efficient you are in providing credit and collecting debt from your clients. Of course, you want to extend credit to the right clients who will pay you on time. As a business, you also have to pay your debts when they are due, so an effective debt collection approach is crucial to your success.
Final Word
When you have these insights on your financial KPIs at your disposal, you can make objective, calculated business decisions based on facts. You can be more focused, proactive, and confident in implementing changes when you see under-performing areas. Using these KPIs means you can quantify your efforts and measure how effective is your business’s performance.
Consequently, knowing these KPIs will help you ascertain better company sustainability and long-term success, paving the way for you to increase your company’s value and net worth. If you need help trying to calculate these various equations for your company, we’ll be glad to help you out. We offer a free consultation, so just drop us a line here.
