Fundamental Financial Metrics and KPIs You Need to Be Tracking
|What are Financial KPIs?|
|Why are KPIs and Metrics Important to Financial Performance?|
|Here are 16 Fundamental Financials KPIs and Metrics to Track Right Now|
The finance department is one of the most crucial parts of any business. After all, this is the department that is responsible for making sure that the company’s finances are in order. It mainly focuses on making sure that money is allocated and distributed to the appropriate business functions, as well as being accounted for.
As you already know, anything involving the handling of money has to have a small margin of error. There is a need for accurately measuring critical aspects of the company’s finances to make sure that its funds are not mismanaged. That is why tracking of financial metrics and KPIs is extremely important.
If you want to know which financial KPIs you or your finance manager should be tracking, keep on reading. With the stakes being high should the finance department not do its job effectively, not tracking the right KPIs can be catastrophic.
What are Financial KPIs?
Before getting down to listing the KPIs, it is equally important to talk about what a financial KPI is. Essentially, a KPI is a numeric value that is used to evaluate the performance of a business. By measuring a KPI, the company knows where it stands performance-wise and how far it has to go to achieve its goals.
Goals can be financial in nature, and financial KPIs help a business track its progress towards the achievement of these types of goals. For example, a financial goal could be to increase revenue by 50% by the end of the year. It is then up to the decision-makers of the company to identify a KPI that will help them make sure this financial goal is being measured.
Why are KPIs and Metrics Important to Financial Performance?
Measuring these KPIs comes with a number of benefits that can simply not be overlooked. The Ultimate benefit of this is that these KPIs ensure the financial success of the business. If the business becomes financially successful, it means more profits. Not only that, but the company can also grow. A business that is not profitable will not grow and can even close down.
The benefits below contribute heavily towards achieving the above-mentioned ultimate benefit.
Evaluate the Financial Health of the Company
Think of your body: it needs to be healthy for it to function at maximum capacity so you can do what you want. What should be high needs to be high and what should be low needs to be low. In order to ensure this, there are some things that you need to check. You can check your temperature to make sure that it is 98 degrees Fahrenheit, which is normal. If it is high, you know something is wrong (probably an infection) and you need to go see a doctor.
This is the same as a business. There are various things that need to be high and some things that need to be low to ensure the company is financially healthy. For example, you need things like net profit margin to be high (this is one of the most important indicators of financial health). If this KPI is low, you know that the company is in serious trouble.
Besides telling you that the net profit margin is low, there are other ways in which KPIs can tell you that your company’s health is in trouble.
Here are a few more:
- Operating expenses increase while revenue decreases or remains stagnant (a business should never spend more than it earns).
- Trouble raising capital to sustain the business and cover operating expenses.
- Having a high debt ratio, meaning the business owes more than it is worth.
- Defaulting on payments that the business owes it debtors, paving the way to liquidation and insolvency.
- The business’s cash balance being on the low side, indicating that the business is unsustainable.
- The business is always spending on attracting new customers instead of keeping new ones (acquiring new customers is more expensive).
Helps the Finance Manager Make Informed Decisions
The financial manager cannot act on what he or she doesn’t know. So when it is discovered that the company’s finances are in trouble, it is up to them to figure out a way to get things back on track and secure the company’s health. This is more likely to happen if they are tracking the right KPIs. By looking at them, the finance manager can extract actionable insights, meaning the resulting decision will be highly informed and effective.
Keeps You on Track With Your Financial Goals
If there are no KPIs being measured, then there would virtually be no way of knowing if the financial goals are being reached. Worst of all, there would be no way to tell if the finance department is falling behind in achieving them. So by tracking these financial metrics and KPIs, the finance department always makes sure that everything they do is always pushing the company towards achieving the financial goals that were set.
Keeps the Finance Department Focused
KPIs are target driven, which means that financial KPIs give the finance department something to focus on. Without targets, it is easy to lose focus. And without focus, it can be extremely difficult to get anything meaningful done. With KPIs in mind, the finance department can channel their resources efficiently towards achieving their targets and positively affecting the company’s financial health.
Helps the Finance Department Solve Problems
By looking at the financial KPIs, the manager will be able to tell if there is a problem that needs to be solved. These problems are what are contributing to the inefficiencies of the finance department. Furthermore, on top of rooting out problems, the KPIs can reveal opportunities for improvement that can positively affect the company’s bottom line in the future.
Here are 16 Fundamental Financials KPIs and Metrics to Track Right Now
With the definition of what a financial KPI is and the benefits it provides out of the way, we can now talk about the important KPIs and metrics the financial department needs to be tracking. This is by no means an exhaustive list and it is only meant to be a starting point. For the financial KPIs to work in your favor, you need to vet each one of them and see if it relates to your financial goals (directly or indirectly).
So without further ado, here are 16 of the most important KPIs and metrics that you need to be tracking right now.
1. Earnings Before Interest and Taxes
Earnings before tax or EBIT is a KPI that measures the amount of operating income the company has. This is the income that the company has made from its day-to-day operations before interest and taxes. This tells the finance manager how much revenue is being earned from the company’s ongoing operations.
To calculate EBIT, you subtract the operating expenses from the operating revenue. Finally, you also subtract the cost of goods sold (COGS) from that figure. An alternative formula is to add the net income, interest and taxes and this will give you your earnings before interest and taxes as well.
2. Economic Value added
Economic value added or EVA is a KPI that measures the additional revenue a company needs to make its shareholders happy. It tells you whether the company created value (made a profit) or not after taking out the capital that was invested in it. If the EVA is positive, then investors can be certain that the company is making good use of its capital investment.
On the other hand, if there was no value created after utilizing the capital investment, then it tells investors that their investments are better off being channeled elsewhere. Tracking this KPI will ensure that you don’t disappoint investors and that you always invest in company activities that bring in more value than they take.
To calculate this figure, you need to multiply the capital and the cost of capital . Then you subtract the resulting figure from the net operating profit after taxes.
3. Gross Profit Margin
For the finance department to tell how well the sales and production teams are performing, they look at the gross profit margin. It tells them how much revenue (in percentage) the business made after COGS has been subtracted from the figure. If the gross profit margin is high, then the sales and production processes are deemed to be efficient enough to run a sustainable operation.
This figure is calculated by taking the total revenue the business made over a period of time and then subtracting COGS. Then the result is divided by the total revenue to reveal the percentage of the gross profit margin.
4. Net Profit Margin
Net profit margin is a big KPI to show investors because this is how they tell if the business they invested in will pay them dividends. Basically, the net profit margin is the percentage of profits the company made after taxes and interest has been subtracted from the gross profit. If all the expenses combined show that they are greater than the revenue that was made, then the company is unprofitable.
To calculate this, you first calculate the gross profits, which is total revenue minus expenses. Then you find your net income by subtracting taxes and interest from the gross profits. Finally, to find the percentage that is your net profit margin, you divide the net income by the total revenue.
5. Day Sales Outstanding
When a sale is made, the money can be obtained instantly. This is most likely the case if you are a shop owner and someone purchases a carton of milk. They will pay for it instantly at the till. However, not all payments happen so fast – where you get the cash immediately. Some of them can take hours, days or even weeks to obtain.
Day sales outstanding or DSO is a KPI applied to the latter scenario. It measures how many days it took to receive payment after you sold something. This is usually the case in business-to-business transactions (B2B), where you need to send in an invoice and then wait for the customer to make a payment.
6. Customer Acquisition Ratio
Customer acquisition ratio is a KPI that measures the relationship between your customer lifetime value (LTV) and customer acquisition cost (CAC).
LTV is the amount of revenue you can expect to earn from a customer during their entire lifespan as a customer. It is calculated by multiplying the average purchase frequency by the average purchase value and the average customer lifespan. CAC is a numeric value that tells you how many customers your marketing efforts brought in and how much you spent to make it happen.
7. Income Sources
As a company, you will probably have a number of income streams, and it is important to keep track of all of them. While others will make you revenue, others might not. This KPI lets you know which ones are worth pursuing further to keep the company profitable. And it also lets you know which ones are dragging your bottom line down and should be let go.
8. Monthly Recurring Revenue
KPIs that measure revenue are usually extremely important and this one is no different. The monthly recurring revenue or MMM is a big KPI in the Sales as a Service (SaaS) industry. It tells these companies how much monthly revenue they can expect on average from their current customers. This is the income that is predictable and relied upon by the business to keep them afloat every month.
SaaS businesses usually derive this figure from multiplying the average revenue per subscriber/user by the total number of subscribers/users. The average revenue per subscriber/user being the revenue the company expects to make from a single paying user.
9. Annual Recurring Revenue (ARR)
Just like MMM, annual recurring revenue or ARR is another big KPI for the SaaS industry. But rather than looking at the value of the subscriber on a monthly basis, it looks at their value on a yearly basis. So, basically, ARR tells the business how much revenue they can expect from their current subscriber base on a yearly basis.
ARR is calculated by simply taking the MRR and multiplying it by 12. So based on the ARR, the company’s decision-makers can justify the sustainability of their current business model. They can also make plans based on this projection on how to make the company even more profitable (if the ARR is good).
10. Current Ratio
To survive, a company needs to be able to meet its obligations in the short term. By looking at the current ratio, executives and investors can be satisfied with the company’s ability to handle its use of current assets effectively without needing any external capital injection. The current ratio is an extremely important KPI because it indicates how liquid a company is.
When calculating the current ratio, you divide the current assets of the company by its current liabilities. Then you multiply the resulting figure by 100 if you are looking for a percentage. By looking at this figure, you will be able to tell what the short-term financial strength of your company really is.
11. Inventory Turnover
When selling goods, a company will usually keep its eye on the inventory levels. This makes sense because it wouldn’t want to underproduce – overproducing the inventory is just as bad. By looking at the inventory turnover KPI, a business can determine how many times its inventory was sold or replaced.
Inventory turnover is a ratio that can be calculated by taking the average inventory and dividing it by COGS. For example, if the COGS for a particular month is $50,000 and the average for the same month is $15,000, then the inventory turnover is 50,000 ÷ 15,000 = 3.33 (rounded).
12. Working Capital
Working capital is the number of current assets the company has to meet its short term liabilities. It is another KPI that shows how liquid the company currently is. It takes into account things like the amount of cash on hand, accounts receivable, cash advances, inventory, prepaid expenses and petty cash. If working capital is low, then the business will need to find external funding to help it meet its short term obligations.
13. Revenue Growth Rate
When a company’s revenue is growing, it means that the company’s financial health is in good standing. The revenue growth rate is what measures if the company’s revenue has seen an increase over a period of time. It can be measured on a monthly, quarterly or yearly basis. So if one of the strategic goals was to grow the company’s revenue by 25% by the next quarter, this is the KPI to check.
Calculating it is a relatively simple process. You subtract the total revenue that was made in the previous period from the one that was made in the current period. Afterwards, you then divide the result by the total revenue from the previous period, multiply the result by 100 and this will give you your revenue growth rate.
For example, let us say you made $1,000 this month and $750 last month. To get the revenue growth rate, it will be (1,000 – 750) ÷ 750 x 100 = 33.3 (rounded). This means that your company saw a revenue growth rate of 33.3%. Whether the figure is good or bad will depend on the goals that have been outlined in your company strategy.
14. Return on Investment
Return on Investment or ROI is an extremely important KPI since it tells you if your investments are paying off. You will normally hear this KPI being thrown around when talking about the company’s marketing campaign. It is one of the major success indicators of investing in a particular marketing channel.
This is a simple KPI to calculate. It is derived by dividing the total investment by the net profit (minus tax, interest and expenses). Then the result is multiplied by 100 to get the ROI.
So if your company invested $2,000 into a marketing campaign and made $5,000 in return, then the ROI is 2,000 ÷ 5,000 x 100 = 40. This means the return on investment was 40%, which is good since you never want this number to be negative.
15. Return on Equity
Return on equity or ROE is another big KPI financial KPI for a business. This one concerns investors who want to know if their investment is paying off. It looks at the shareholder equity that was listed on the balance sheet and the revenue the company made after taxes. It reveals if the company can be viewed as successful on the shareholder level.
To calculate ROE, you have to divide the net revenue by the shareholders’ equity. Afterwards, you just multiply that by 100 to get a percentage that represents the ROE. If this number is positive then it tells investors that the company was efficient in using their investment dollars, considering that profits were realized. If it is negative, it means the company is losing its investment dollars.
16. Revenue Per Employee
When a company needs to look at how efficient an employee is, they look at the revenue per employee KPI. Depending on what the employee is bringing in compared to the overall revenue of the company, you can tell if they need to up their game or not. This figure is a good motivational tool to make people bring in more revenue.
To calculate the revenue per employee, you have to divide the company’s total revenue by the total number of employees. That number will tell you just how every employee should have contributed to the total revenue. Then you just have to check if their actual figures are above or below this to determine their performance.
So there you have it, the most important financial KPIs and metrics you should be tracking. By looking at these, you should be able to tell how financially strong your company is. And most important, they will guide you towards meeting your financial goals.