A business has many priorities. but some are more crucial than others. The financial well-being of a business is one such priority. But how do you keep a track of the financial well-being of business? Enter Financial KPIs.
A parallel can be drawn between the human body and business to understand this better. If financial health is the heart of the entire organization, then financial KPIs are measures like cholesterol and heart rate. You want to monitor them closely because even a small glitch can cause the entire system to go down.
In this article, we shall be answering the following key questions regarding Financial KPIs
- What is a Financial KPI?
- How to measure Financial KPI?
- Which are the most important Financial KPIs for your business?
So let’s quickly dive in.
A Financial KPI or metric is a measurable value that indicates a company's financial results and performance, provides information about expenses, sales, profit, and cash flow, to optimize and achieve the business' financial goals and objectives. These are also considered key performance indicators for finance departments in companies.
Additionally, a Financial KPI should be SMART which means that it should be
- Specific
- Measurable
- Achievable
- Realistic
- Timely
While there are many such indicators, below are the 4 absolute most crucial areas for which the financial KPIs should be tracked by any business. These areas are:
- Cost
- Revenue
- Profit
- Liquidity
These sections and related financial KPIs may appear on your income statement, or your balance sheet as well. So it is important that you are aware of and tracking these from an early stage.
Cost KPIs
Cost indicates the investments either short-term or long-term that go into the business and its offerings – products or services. Rent, machines, or staff – everything has a cost, and it is critical to have a clear idea about them.
Cost of goods sold, variable costs, operating expenses, inventory costs, labor costs, marketing costs etc are some of the examples of various cost headers you would want to track for your business.
Without understanding input costs, it’s tough to build a profitable business. Consider the cost as the first Financial KPI on which a successful business is built on.
Revenue KPIs
Every action in a business is driven by this question.
What revenue will this generate?
After all the point of being in business is to make money.
It is one of the most important Financial KPI that there is.
So what drives revenue for the business?
The resounding answer is Sales. A sale is an activity through which revenue gets generated for a business.
For example, if a business is selling a product for $100 each and it manages to sell 100 such products, then the total revenue for the business is $10,000.
Total revenue is also known as Sales turnover of the business.
However, sales numbers can be further broken down into equally important metrics such as the following to gain more insight.
- Which product/SKU/ service generates maximum revenue ( meaning the fastest-selling product or service)
- Which market or customers is the revenue generator ( meaning the geography or buyer who gives maximum sales to business)
- What are revenue running rates – Daily/ Monthly / Yearly (meaning the average sales on a daily, monthly, or yearly basis)
Armed with all the above information, a business develops a deep understanding of its revenue stream.
This information takes us to the next important Financial KPI
Profit KPIs
Profits are the net takeaway for any business. It is in the true sense the proverbial golden pot at the end of the rainbow for which every business puts in all the efforts. However, there lies an important distinction between two profits which is crucial for any business to understand. Every business generates two kinds of profits.
- Gross profit
- Net profit
Gross Profit: It is a good indicator of how much money you are making on each unit or product you are selling. It's derived when you remove the Cost of Goods/ Services from the Revenue you generate out of sales. This helps to focus on what product or service is most profitable for any business.
Net Profit: This is generally not calculated on the sale of a single transaction but after having done multiple transactions in a defined time frame like a financial year.
To arrive at a Net profit, two key factors need to be calculated.
Total revenue generated and total expenses
Carrying ahead the example quoted above after selling 100 products of $100 each, earning is $1000. This is the total revenue.
But the cost of producing each such product is $30. So the cost of production of 100 units is $3000.
Besides, the business had to spend $1000 for promotion and advertising to ensure sales.
So the net profit is as following
Total revenue - $10,000
Cost of goods produced - $3000
Cost of Promotion and advertising - $1000
Net Profit = $10,000 - $3,000 - $1,000
= $ 6,000
This is what the business earned after sales of 100 units
It is also called the Bottom line of the business. This is the money the business owner earns at the end of the process.
Liquidity KPIs
Immediately available cash is "working capital". Working Capital is arrived at by subtracting your business's existing liabilities from its existing assets.
Cash on hand accounts receivable, short-term investments are all included, as well as accounts payable, accrued expenses, and loans are all part of this KPI equation.
This especially meaningful Financial KPI informs you of the condition of your business in terms of its available operating funds, by showing the extent to which your available assets can cover your short-term financial liabilities.
A good indicator of this parameter is the current ratio which is arrived at by looking at two important constants of business – Assets and Liabilities.
Assets are the items your company owns that can provide future economic benefits. While Liabilities are what you owe to other parties. In short, assets will put money in your pocket, and liabilities will take money out.
Current Ratio is a measure of the ability of the organization to satisfy all current liabilities using only the current assets.
Current Ratio = Current Assets/Current Liabilities
A current ratio of <1 means that company may run into short term liquidity issues.
Conclusion
The key to having a successful business lies in knowing the right information which is consistent with the overall strategy. Financial KPIs allow you to detect this much before they start showing on business in a significant way.
At Deskera, we want to ensure that small businesses continue to thrive while we provide them the best inputs using the latest technology and tools. This article is our way of educating our patrons on the basics of Financial KPI and how we can provide a one-stop solution that covers all of these.
You can sign up for a free trial of Deskera to keep a track of important financial KPIs in real time.