Posted by Neha De
February 3, 2022 | 6-minute read (1033 words)
Financial key performance indicators are metrics businesses use to track, quantify and analyze their financial health. By understanding these KPIs, business owners can be better positioned to know how their companies are performing from a financial perspective. They can then use this information to adjust the goals and contribute to critical strategic objectives.
Financial KPIs allow business owners to stay focused on the big picture, steer their firms in the desired direction and identify any pressing issues without getting bogged down with the minute details. These KPIs also tell them when operations are running smoothly and alert them to any warning signs or significant changes.
In short, financial KPIs help businesses:
• Figure out whether or not they are on track to reach their financial goals.
• Assess the success of their strategy based on the KPIs.
• Identify areas in the business that may need an upgrade.
• Determine any challenges as well as opportunities.
• Evaluate whether customers are happy or not.
15 financial KPIs to measure business performance
1. Gross profit margin – Gross profit margin reveals how much of the total revenue is profit after factoring in expenses such as the total cost of production. It is a profitability ratio that calculates what percentage of revenue is left after subtracting the cost of goods sold.
Cost of goods sold includes all direct expenses associated with a product, that is, the direct cost of production. It does not include overheads such as taxes, operating expenses or interest payments.
Gross profit margin can be calculated using the following formula:
Gross profit margin = (revenue – cost of sales) / revenue x 100
2. Net profit – A business’ net profit is basically its bottom line. It is the total cash left over after all bills have been paid. Net profit is also known net income, and accounts for both direct and indirect expenses.
The formula for calculating net profit is:
Net profit = total revenue – total expenses
3. Net profit margin – Net profit margin is a profitability ratio that calculates what percentage of revenue and other income is left after removing all costs for the company, such as operating expenses, costs of goods sold, taxes and interest — and not just the cost of goods sold.
The formula for calculating net profit margin is:
Net profit margin = net profit / revenue x 100
4. Working capital – The working capital of a business is a measure of its operating liquidity, which can be used for day-to-day operations.
Working capital can be calculated using this formula:
Working capital = current assets – current liabilities
5. Current ratio – Current ratio is a liquidity ratio that helps businesses understand whether it can pay its short-term obligations with its current assets and liabilities. Companies can use this metric to find out if they have the necessary cash on hand to fund a large purchase.
Current ratio can be calculated using this formula:
Current ratio = current assets / current liabilities
6. Quick ratio – Also called an acid test ratio, quick ratio is also a liquidity ratio that evaluates a company’s ability to handle short-term obligations. This KPI uses only highly liquid current assets, such as cash, accounts receivables and marketable securities, in its numerator. It is taken for granted that some current assets, such as inventory, cannot easily be turned into cash.
This is how you arrive at the quick ratio:
Quick ratio = (current assets – inventory) / current liabilities
7. Debt-to-equity ratio – The debt-to-equity ratio is a solvency ratio that calculates how much a business finances itself using debt versus equity. This metric offers insight into the company’s solvency status by reflecting the capability of shareholder equity to cover all debt in case of a downturn.
The formula for calculating debt-to-equity ratio is:
Debt-to-equity ratio = total debt / total equity
8. Inventory turnover – This metric is an efficiency ratio that calculates how many times per accounting cycle an organization sold its full inventory. The inventory turnover KPI provides insight into whether a business has excessive inventory in relation to its sales levels.
Inventory turnover can be measured using the following formula:
Inventory turnover = cost of sales / (starting inventory + ending inventory / 2)
9. Total asset turnover – The total asset turnover metric is another efficiency ratio that calculates how efficiently a business uses its assets to generate revenue. A higher turnover ratio means well performing business.
The formula for calculating total asset turnover is:
Total asset turnover = revenue / (starting total assets + ending total assets / 2)
10. Return on equity – This is an important KPI to measure if there are shareholders. It demonstrates how successful a business is at generating profit for its investors.
Return on equity can be calculated using this formula:
Return on equity = net income / shareholder equity
11. Return on assets – Another profitability ratio, return on assets reveals how well the business is at managing its available assets and resources to earn higher profits.
The formula for calculating return on assets is:
Return on assets = net profit / average total assets
12. Customer acquisition ratio – This KPI indicates how much revenue is earned per new customer.
The formula for measuring customer acquisition ratio is:
Customer acquisition ratio = total expected lifetime profit from customer / cost to acquire customer
13. Operating cash flow – Operating cash flow is a liquidity KPI metric that measures an organization’s ability to pay for short-term liabilities with cash generated from its core operations.
Operating cash flow can be calculated using this formula:
Operating cash flow = net income + non-cash expenses + change in working capital
14. Accounts receivable turnover ratio – The accounts receivable turnover ratio calculates how well a business can collect cash from credit sales. A higher accounts receivable turnover ratio is better for a business because it indicates that customers are paying faster.
The formula for accounts receivable turnover ratio is:
Accounts receivable turnover ratio = net credit sales / average accounts receivable
15. Seasonality – This KPI measures how the period of the year is affecting an organization’s financial outcomes and numbers.
When it comes to financial KPIs, there is no absolute right or wrong. These metrics should be compared with previous years or competitors in the industry to determine whether a firm’s financial performance is advancing or shrinking, as well as how it is performing compared to others.