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15 Fundamental Financial KPIs and Metrics for Business Success

written on 20-3-16-Mon 11:07
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Key performance indicators (KPIs) are quantifiable values that indicate whether a business is meeting its targets or not. Irrespective of the company's size, type, or industry, every business should track a number of them to get a better understanding of its overall performance.

For companies that are in business to make profits, the need for KPIs cannot be overemphasized. Not only are they useful for internal business purposes, but they also keep potential investors, stockholders, customers, and other stakeholders in the loop of the company's financial status.

This guide breaks down fifteen of the top financial KPIs and metrics that can spur business success.

What are Financial KPIs? 

Financial KPIs

Financial KPIs are quantifiable metrics that explain how well or badly a business is doing with regards to the revenue generated, profits realized, or any other financial objective. For finance managers that care about a business's status, tracking financial KPI s might give the said business a competitive advantage.

In tracking financial KPIs, most businesses set up dashboards that display real-time updates on their financial status. However, KPI reports give a more detailed view by measuring KPIs against the goal or objective that a business wants to achieve.

Here are fifteen of the top financial Key Performance Indicators to track if you want to improve your business' financial health:

1. Earnings Before Interest and Taxes (EBIT)

EBIT is the KPI that explains a business's profitability. It is an indicator of what a business is earning from its ongoing operations, excluding the interest it gains and the taxes it has to pay to the government. Furthermore, as an income statement metric, it doesn't include the revenue or expenses of non-recurring businesses. 

The formulae for this KPI is:

EBIT = Total Revenue – Operating Expenses

Interest is excluded because it depends on your financial structure, while taxes are left out because they depend on the business's geographical location. Therefore, if your goal is to buy or invest in a company and its financial structure is not as important as the earnings potential, then this KPI might be the ideal one to use.

2. Economic Value Added

Another financial KPI that provides information on a business' financial performance is the Economic Value Added (EVA). The premise of this KPI is that true profitability happens when shareholders get additional income and that the projects a business engages in create returns that are greater than its initial capital cost. 

EVA is useful because it shows the sections where wealth was created by including items you will find on a balance sheet (assets, liabilities, and owner's equity). Furthermore, it ensures that managers and departmental leaders are keeping tabs on their assets and expenses while they make important business decisions. 

Mathematically,

EVA = NOPAT – (WACC x economic capital invested in the business)

NOPAT refers to the Net Operating Profits After Tax, and it is usually provided as a public record.

WACC stands for Weighted Average Cost of Capital

Capital invested in a business = total assets – current liability

3. Gross Profit Margin (GPM)

A business' GPM refers to the money remaining from sales after settling the books for a business' cost of goods sold. Gross Profit margin is a measure of a business's financial health and is also referred to as the gross margin ratio since it is expressed in percentages. 

To calculate the Gross Profit Margin of a company, you must first know the gross profit. 

GPM in percentage = (Gross Profit / Net sales) x 100

Where, Gross Profit = Revenue from net sales – Cost of Goods Sold (COGS)

Net sales = Gross revenue – (allowance + discount + returns)

Gross Profit is an important financial KPI because it tells key decision-makers whether or not the business is better than its competitors in meeting customer needs. It also shows if the company can comfortably fund its costs of operation and still have leftover funds for other projects. 

4. Net Profit Margin

A company's net profit margin is an important KPI because it shows the fraction of a business' income that is created from its revenue. Mathematically, the net profit margin is expressed as a percentage: 

Net Profit Margin = (Net Income/ Net Revenue) x 100

Where the net income equals the net revenue less the business' expenses.

The Net Profit Margin of a company should be tracked by not only the business but also shareholders because it indicates the growth prospect of the company.

It is a preferred KPI to measure than the revenue of a company because the operating cost of companies may increase with an increase in its total revenue.

5. MRR and ARR

MRR stands for Monthly Recurring Revenue, while ARR represents Annual Recurring Revenue. They are KPIs that indicate the revenue that subscribers bring to a business monthly and yearly. 

On the surface, calculating MRR and ARR does not seem complex. All you have to do is sum the revenue you get from your subscribers monthly and yearly. For example, a business that has 20 subscribers who pay $300 every month has an MRR of $6,000. The ARR for the same customers paying the same amount over a year is $72,000. 

MRR and ARR calculations become tricky when you need a forecast of their values and not the current numbers. In such situations, you might need a tool to help you achieve that.

Although MRR and ARR are not part of the Generally Acceptable Accounting Principles (GAAP), the KPIs are great in assessing a company's growth and revenue. 

6. Current Ratio

Current ratio is the KPI that shows a business's ability to fulfill all its financial obligations in a fiscal year. As a liquidity ratio, the working capital ratio (as it is often called) compares the current assets and liabilities of a business. From this information, managers and departmental heads can assess whether a business can pay up its debt with the assets. 

Here's how this KPI is calculated:

Current ratio = (Current assets/current liabilities)

A business's current ratio should be in line with the industry's standard. If it is far greater than this standard value, then the company might be underusing its assets. On the other hand, a low value shows that the company cannot handle the financial obligations it has with its assets. 

This KPI is frequently used by investors to find out more about the operating cycle of a business. 

7. Revenue Growth

As the name implies, revenue growth is a KPI that shows the increase in a business' sales between periods in its cycle. Revenue growth is frequently expressed as a percentage. 

For example, let's assume a business, through its activities, generates $100 million in revenue over a year, and $200 million in the next year. This means it had a growth of 50%. 

Therefore, the formula for calculating revenue growth is:

Revenue growth = (revenue generated in the current period – revenue generated in the previous period)/ Revenue generated in the previous period) x 100

8. ROI and ROE

Another top financial KPI pair that businesses should consider tracking is the Return on Investment (ROI) and the Return on Equity (ROE). 

ROI refers to the financial benefits of purchasing or investing in something. It is a versatile KPI that is used in analyzing the returns of fixed capitals, strategies, and projects, training programs, etc. 

The formula for calculating the return on investment is given as:

ROI = (Net return / Cost of investment) x 100

For example, let's assume an organization buys a piece of equipment for $10,000. In the year, if the sales of products this equipment helps to manufacture equals $14,000, then the return of investment is 40%. From this value, the organization can then determine whether or not it should invest in more of this equipment.

On the other hand, Return on Equity refers to the ability of a company to use the investments of shareholders (its assets) to make profits.

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Mathematically, ROE is expressed as a percentage:

ROE = (Net income/ Average shareholder equity) x 100

The acceptance of the return of equity in an organization depends on that of its competitors. For example, if a company has an ROE of 20%, whereas its competitors can only achieve an ROE of 15%, then investors and managers can conclude that the business is averagely making better use of assets and shareholder investments in creating profits. 

9. Working Capital (WC)

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This refers to the assets a company has to achieve its short-term financial goals. Also known as net working capital, this KPI measures a business's efficiency of operations and liquidity in the short term. Having a positive working capital implies that the business has the potential to grow and can fund its activities. However, a high working capital doesn't mean that all is well with the business. It might imply that the company is not using its excess capital. 

In calculating the working capital of a business, the assets it has in a period are compared with its liabilities. 

Working capital = current assets – current liabilities

10. Burn Rate

Another financial KPI that companies should consider tracking is the burn rate. This KPI measures the rate at which a business spends its venture capital to fund its overheads. As an indicator of cash outflow, burn rate is usually expressed as the cash a business spends per month. For example, if a business, say Tech9ine, has a burn rate of $10,000, then this implies that it spends $10,000 in a month. 

Burn rate is an important KPI because it reveals to managers and investors the amount that a new startup spends before it starts making profits. Some investors also use this KPI to determine the time a startup business has before it doesn't have money to spend again. This time is known as the runway. For example, if Tech9ine has a burn rate of $10,000 and it has $1 million in savings, then its runway will be 100 months. 

11. Operating Cash Flow

Operating cash flow (OCF) is a KPI that shows how much cash a company generates from its every-day business operations. Therefore, the KPI measures whether a business needs financing or it has a fluid enough cash flow to carry out its activities. 

As a clearer picture of a business's operations, OCF strips all accounting anomalies. When calculating this KPI, things like inventory changes and depreciation are adjusted.

Therefore, the formula to calculate the operating cash flow is:

OCF = Net income - (Increases in working capital + non-cash expenses)

Net income is often confused with operating cash flow because the two KPIs somewhat intercept. However, the differentiating factor is in the accounting principles (that is, the accrual and matching principles) used when preparing statements for the two KPIs. 

12. Acid-Test Ratio

The Acid-test ratio is a KPI that shows whether a company has enough assets to fund its future-liabilities in the short-term or not. 

Also known as quick ratio, many companies prefer to use this KPI because it does not take into account their inventory, as well as any other asset that may liquidate. 

Mathematically, acid-test is expressed as 

Acid-test = (Cash + marketable security + account receivable)/ short-term liabilities

If a company has an acid-test ratio of less than one, then this might imply that it doesn't have sufficient assets to cater for its short-term liabilities and vice versa. 

The acid-test KPI is often compared to the current ratio KPI, and if the latter is far lower than the former, then the company depends greatly on its inventory. 

13. Current accounts receivable

Current accounts receivable refers to the cash debtors owe a business. This definition also includes services rendered or goods delivered to a customer that have not been paid for. On a company's financial records, current accounts receivable is regarded as current assets.

Account receivable is an important KPI because it tells a company about its capability to recover its funds without having to spend or incur costs. It also helps businesses plan cash flows and expansions.

Having a high account receivable is not always a good thing for a business because it sometimes shows that it isn't capable of getting money from long-term debtors. It could also imply that the company is giving out many goods and services on credit. 

14. Current Accounts Payable

Current Accounts Payable is the opposite of current accounts receivable. It is a KPI that shows whether a business is meeting its financial obligations and paying off its debts or not. On the company's financial statements, this KPI is treated as short-term liabilities. 

For example, most companies do not generate electricity by themselves and rely on the government or a vendor to supply it. Every day, the company consumes electricity. However, this daily consumption isn't paid immediately but usually at the end of each month or quarter. For such a company, daily electricity consumption is regarded as current accounts payable since it uses electricity for credit in the short term. 

Tracking current accounts payable reveals to a business if it can pay off all its debt with its short-term assets or not. 

15. Debt-to-Equity Ratio

Lastly, the debt-to-equity ratio is a top financial KPI that measures how much of a business' equity and debts it uses in funding its assets. It also reveals the shareholder's equity that may be used to fulfil a creditor's obligations if the business fails. 

Mathematically, this ratio is expressed as 

D/E ratio = (Total liabilities/ total shareholder's equity)

Where Total Shareholder's equity = Total assets – Total liabilities

A high value of the D/E ratio implies that the business is getting a huge portion of its funds by borrowing money, which might be a risky venture. 

Although this KPI might be worth tracking, you need to consider the company's industry before using it. For example, industries that require lots of initial capital investments may have high D/E ratios because companies might take out loans to purchase these assets. On the other hand, servicing companies may have smaller values of this ratio since they may not need large capital investments. 

How to Choose the right Financial KPI for your Business

While it is important to track financial KPIs, focusing on the wrong ones can be detrimental to your business.

Here are the steps to follow in choosing the ideal financial KPIs for your business:

1. Define the goals you want to achieve 

The first step in getting the right KPI for your business is to define the goals you want to achieve by tracking them. The goals must be based on solid figures. For example, "increase customers by 15% over the next quarter" and "reduce unsubscribers by 40% over the year" are well-defined goals.

KPIs should relate directly to these goals for them to be relevant to your company/business. 

2. Bring out strategies from these goals

Since there are multiple ways to achieve an objective, the next step is to find the best strategy that'll help you achieve your goals. If you don't have a strategy, any KPI will seem like the perfect one to use in your business. 

3. Look for KPIs that are SMART

SMART is an acronym for Specific, Measurable, Achievable, Relevant, and Time-Bound. 

Financial KPIs

  • Specific: This means the KPIs hit the nail on the head and are not generic or vague. 
  • Measurable: This means that you should be able to identify when you achieve your goals by looking at your KPIs.
  • Achievable : This explains that KPIs should be realistic, and they should relate to a goal that can be achieved.
  • Relevant: This means that the KPI is useful to the person or business that intends to use it because it provides insights on what needs to be changed or continued.
  • Time-bound: This means that the KPI should have a date that it is tracked and measured against. 

4. Keep the list concise and differentiate between leading and lagging KPIs

Having too many KPIs is confusing. So, keep the list of the ones you need short and concise. An organization should have between 5 and 15 KPIs. 

At this stage, you also need to distinguish between leading and lagging KPIs. A lagging KPI measures the overall business performance and the outcome of past actions. They are often used by managers, leaders, and influential stakeholders in businesses. 

Leading KPIs, on the other hand, are the business drivers that explain how likely it is to reach a goal in the future.  

5. Review the KPIs you've shortlisted 

The final step is to review the KPIs and make sure they address your business' needs.

Final Words

Financial key performance indicators (KPI) are important to businesses that have targets because they reveal the level that these targets have been reached. Tracking, measuring, and reporting them also helps businesses make better decisions. 

In this article, we've explained the top 15 financial Key Performance Indicators that you should consider measuring if you have a financial objective you want to achieve.

Frequently Asked Questions

Q1. How often should you measure a financial KPI?

KPIs should be measured as frequently as required. However, most financial KPIs are measured every fiscal year or quarter.

Q2. What is a KPI dashboard?

A KPI dashboard is a one-page screen that gives the breakdown of all the KPIs that a business is tracking and their values. They are a good way to ensure that decision makers have the most important information to help them achieve objectives.

Q3. How do I measure a financial KPI?

Financial KPIs can be calculated and measured manually. However, since there are many inputs, these calculations can get a bit confusing. Another way to measure financial KPIs is by using a software.

Q4. Can I use more than one KPI for a single business objective?

Yes. You can use more than one KPI for a single business objective. However, make sure that none of them are redundant and irrelevant to your business. Instead, they should complement one another. For example, current accounts payable and current accounts receivable are two KPIs that work hand-in-glove in achieving the goal of increasing a business' cash at hand.

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