Essential Financial KPIs Every Business Should Track
Jun 17, 2023 | 18 Min Read
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What are Financial KPIs?
The Importance of KPIs for Businesses
- Monitoring and Evaluating Performance: KPIs provide insights into the business’s financial performance, enabling managers to make informed decisions. Regularly tracking KPIs helps identify trends or anomalies in data allowing managers to take corrective actions to improve in areas where the business is lacking.
- Make data-driven decisions: Businesses can leverage KPIs to support their decision-making process. For example, revenue growth and profitability indicators can be used to evaluate a potential expansion and the risks associated with it. By setting KPI targets, businesses can also assess their performance and evaluate whether they are in line with expectations or for any reasons for deviations.
Different Types of Financial KPIs
Financial KPIs encompass both qualitative and quantitative measures that provide valuable insights into business performance. They can be categorized as below:
Revenue and Market Share KPIs:
Gross and Net Revenue: Gross revenue is the revenue generated by the business before any deductions or discounts. The revenue remaining after discounts, sales returns, and allowances is called net revenue. They represent the overall sales performance of the business.
Sales Growth: This measures the growth rate of sales over a specified duration of time. It indicates the success of the sales strategy of the business and is often used to evaluate the marketing efforts of the company.
Market Penetration: It assesses the percentage of the market the business has captured over time, indicating the success of expansion efforts and performance in new markets.
Customer Acquisition Cost: This is a measure of the cost of attracting a new buyer to the business. It is an evaluation of the marketing and sales strategy departments. Keeping this as low as possible is essential for small businesses with low resources.
Profitability KPIs:
Gross Profit Margin: It determines the percentage of sales remaining after deducting the cost of goods sold. It measures the efficiency of the pricing strategy as well as the production and/or purchasing process of the business.
Net Profit Margin: This ratio determines the percentage of sales remaining after deducting all business expenses. It gives an indication of the overall profitability of the business.
Return on Investment: This measures the return generated from the investments made in the business. It evaluates the effectiveness of the capital allocation and investment decisions of the managers.
Liquidity and Cash Flow KPIs:
Current Ratio: The current ratio is a measure of liquidity. It assesses the business’s ability to meet short-term obligations.
Cash Conversion Cycle: It is a measure of cash flow management. This metric determines the time taken to convert inventory into cash.
Operating Cash Flow Ratio: It indicates the ability to generate cash to fund the day-to-day operations of the business. It measures the cash flow from operations relative to total operating expenses.
Efficiency KPIs
Accounts Receivable Turnover: This measures the time taken by customers to pay off existing invoices, reflecting the effectiveness of the company’s credit policies. It is desirable for a company to have a quicker collection period.
Inventory Turnover: Inventory turnover measures the efficiency of the sales performance and inventory management of a business by determining the number of times inventory is sold and replenished over a given time. Monitoring inventory turnover can help identify slow-moving items, reduce warehousing and storage costs, and ensure inventory is sufficient to meet customer requirements.
Return on Assets: It measures the return-generating capability of the assets employed in the business.
Debt and Financial Risk KPIs:
Debt to Equity Ratio: This KPI assesses the capital structure of the business. It is essential to keep track of this ratio to prevent the risk of overburdening the company with extreme levels of debt.
Interest Coverage Ratio: It measures the company’s ability to meet its interest payments. In addition to these quantitative KPIs, some qualitative ones can provide crucial insights into non-financial aspects of the business such as customer satisfaction, brand perception, and so on. These are normally measured through surveys and feedback from customers. While they are not a direct indication of financial performance and health, they play a crucial role in the betterment of a company’s financial performance. They reflect intangible assets and factors that are important for long-term sustainability such as customer behavior and brand engagement.
By incorporating qualitative KPIs, businesses can have a comprehensive understanding of their financial health and make informed decisions for financial success and growth.
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How to Measure and Track Financial KPIs
Measuring and tracking financial KPIs are essential for businesses to gain valuable and regular insights into the financial position of the business.
This can be done by:
Utilizing Financial Statements: Making use of the financial statements of the business such as the basic balance sheet, income statement, and cash flow statement can help extract a wealth of data essential for measuring KPIs. This data can include the expenses, incomes, assets, liabilities, and cash flow position of the business.
Leveraging accounting software: The use of accounting software can be very beneficial to businesses as they can gain access to the real-time performance of the business. The accounting software can generate the required KPIs on a real-time basis as well as provide dashboards, graphs, and other vital data, allowing managers to regularly monitor their required KPIs and make informed decisions. Creating alerts for when KPIs are met, exceeded, or missed should be considered as well. To fully leverage accounting software, outsource your accounting needs to professionals such as Accountimize, who make use of the best-in-class technology and software to optimize your accounting needs.
Employing Data Analytics: Data analytics tools can provide businesses with a comprehensive analysis of their financial data by identifying trends and detecting anomalies and hidden opportunities or risks. Data analytics tools often use charts, graphs, and interactive dashboards, making it easier to monitor and communicate the financial KPIs of the business to stakeholders.
Benchmarking Financial KPIs
Benchmarking is the practice of evaluating one’s performance with industry standards, competitors, or historical performance.
Benchmarking is essential for businesses to identify areas for improvement. This can be done by comparing the performance of their business with industry standards or competitors to identify areas the business is lacking. For instance, a lower net profit margin as compared to competitors suggests the need to assess the cost structure of the business or implement strategies to improve sales and profitability.
Similarly, benchmarking can assist in setting realistic goals, based on industry best practices. By analyzing the financial KPIs of industry leaders, businesses can replicate their best practices to improve their own performance.
Benchmarking helps identify innovative approaches to business processes, operational improvements, and other valuable information that can drive business growth.
Limitations of Financial KPIs
Financial KPIs come with a range of advantages. However, it is important to recognize their limitations as well, which are discussed below.
Seasonality: Financial KPIs are often influenced by external factors such as seasonal trends or other market factors. Failing to account for these trends can result in inaccurate decisions. For example, a fall in sales due to cold weather is more of a seasonal matter for an ice cream vendor rather than a misinformed business decision. Therefore, it is important to consider the broader business dynamics when analyzing financial KPIs.
Qualitative Aspects: Financial KPIs do not capture crucial qualitative factors such as brand perception, customer satisfaction, and innovation. While this data may not be directly reflected in the basic balance sheet and other financial statements of the business, it is essential to supplement quantitative financial KPIs with non-financial indicators for a comprehensive understanding of the overall business performance.
Comparability: KPIs are meaningless in isolation. They must be compared with other indicators and benchmarks specific to the same industry. Cross-industry comparisons are of limited or no benefit due to differences in market structure, product, and pricing categories as well as many other key factors.
Lagging Indicators: Financial KPIs are often based on historical data of the previous period as they are extracted from financial statements. They provide insights into past performance rather than future expectations. It is essential to focus on leading indicators that give insights into future performance and challenges.
Subjective: Different accounting methods and estimations can lead to variations in the KPIs measured. It is essential to have consistent accounting practices to ensure comparability and accuracy of financial KPIs over time.
Best Practices for Effective KPI Implementation
Once the business sets its objectives for the period, it is essential to align its financial KPIs with its chosen strategy, be it sales growth or profitability. Similarly, businesses should constantly monitor, add, and modify KPIs based on current business conditions.
Furthermore, it is vital to employ robust accounting systems to ensure the accuracy and integrity of all underlying data, as financial KPIs are extracted from this platform.
All relevant KPIs and their importance should be well-communicated to all stakeholders and ensure that everyone understands how their actions can affect the relevant KPIs. Targets for each KPI should be set, which are challenging yet achievable, encouraging continuous improvement. KPIs should be regularly reviewed, while teams should be rewarded for achieving targets, creating a sense of ownership and accountability. Businesses should also foster a culture of continuous learning and improvement by promoting knowledge-sharing and collaboration.
By following these best practices, businesses can leverage financial KPIs to contribute towards the overall success of the business.
Why outsource your accounting needs to Accountimize:
As a small business owner, managing your accounting needs and simultaneously running your business can be quite challenging.
We, at Accountimize, understand the challenges of managing accounting needs as well as efficiently measuring and monitoring financial KPIs.
Our experienced team of CPAs can assist you in setting relevant KPIs specific to your industry, benchmarking, and tracking them over time. By understanding how your business stacks up against competitors, we can help you identify areas for improvement and make data-driven decisions to optimize your business operations.
With our comprehensive solutions, including but not limited to bookkeeping, tax compliance, payroll accounting, and financial reporting, you can gain peace of mind knowing that your accounting needs are in capable hands.
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