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This blog was first published in 2021 and updated on October 25, 2022.
Whether your business objective is demonstrating shareholder value, scaling your business or increasing productivity and profitability, tracking financial KPIs can help you get there. They will provide you with insight into the big picture and allow you to drill down into specific areas of your business.
Financial KPIs are a critical component of business strategy, allowing you to track progress, assess success and identify key opportunities and challenges. But they are not just for finance departments. Here are seven financial KPIs that should be an integral part of your business strategy and monitored by your management teams.
Gross profit margin measures competitive advantage and it's used strategically to inform decisions about human resources, pricing and your supply chain. Calculated by subtracting the cost of goods sold from total revenues, gross profit margin reveals how efficient your company is at turning sales into profit. Use it to analyse overall revenue or specific products.
You can also use gross profit margin to assess sales performance and compare it with your competition. It can also provide an assessment of the overall competency of the management team as low gross profit margins can indicate poor management. However, temporary increases in production costs can also cause your gross profit margin to fluctuate. This may indicate the need for a price adjustment or cost-cutting measures.
It's an imperfect measure of profitability because it does not consider the indirect costs of making and selling your product, including administration, research and development. While high gross profit margins can indicate financial health, context is critical. For example, if a product is overpriced, you may be sacrificing both potential volume and sales growth.
Operating margins assess profitability since they measure how much profit you make after paying variable production costs. They reveal how well core business operations perform, but are also helpful for strategic planning in several areas. This is the margin that investors and lenders will pay close attention to and focusing on this ratio helps identify potential risks and red flags and opportunities.
Operating margin is a strong indicator of risk as well as performance over time. Lower operating margins can indicate higher risk, but may also reveal rapid growth within a company. Understanding this margin and why your ratio is low or high ensures you can defend your company's financial position to investors and lenders. Leverage it to inform other strategic decisions on hiring, supply chain management, pricing and even marketing.
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Net profit margin is challenging to track, but it can offer the most insight into your company's general financial health. A company may be profitable, but it might not be in a healthy position without a substantial profit margin. Net profit margin tracks generated profit as a percentage of total revenue and considers all expenses, including interest.
While net profit margin is helpful for financial planning of tax strategies, forecasting, servicing debt and raising capital, it has other strategic uses. Net profit margin allows you to identify and address potential areas of profit loss. Operations, for example, can use it to assess supply chains and negotiate better terms and conditions or evaluate the return on investment for specific expenses.
If profit margins provide insight into the financial health of an organisation, working capital provides a snapshot of general efficiency, liquidity and financial health at a specific moment in time. This ratio divides current assets by current liabilities and measures whether a company has sufficient cash flow to cover its short-term debts and expenses.
If sales are cyclical, tracking working capital can help you plan for periods when sales are down. You may need to maintain access to a working capital line of credit or free up more cash. Sales managers can renegotiate payment terms or offer an incentive to customers who pay early. If negative working capital persists over a longer period, it may become necessary to cut expenses. On the other hand, too much working capital is also a problem as it represents idle money. Use it to reduce debt or reinvest in the company.
Budget variance is a valuable metric for tracking the difference between budgeted and actual figures. Managers can use it to track expected and actual expenses for a project, labour or production costs and shipping--essentially all expenses you must account for in your business. It's important to identify whether any negative variances are from controllable or uncontrollable factors. The former suggests poor planning, while the latter is unavoidable.
Budget variance confirms the accuracy of budget assumptions and is a good measure of financial projections. It can be used to inform decisions about everything from outsourcing to pricing. It can also identify areas of overspending or opportunities to expand in specific product lines, for example. Finally, use budget variance strategically to either raise or lower established financial and other benchmarks.
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With the growth of part-time and contract work, tracking full-time equivalents (FTE) is more important than ever. This metric tracks how many full-time workers your part-time staff is equal to and provides insight into the productivity of your part-time and contract workforce.
FTE is a critical metric for resource planning in project management and can help ensure the accuracy of workforce planning in general. FTE can help you decide if you can afford a new hire and measures general labour costs for long-term planning. It is also helpful in accessing tax credits or government incentives linked to employment.
Sales growth is a powerful metric that can serve as a motivator and a financial check. It provides valuable information for managers and senior executives in finance and human resources. For example, sales growth can gauge the success of a specific sales growth target. Individual managers might track sales growth for specific salespeople or even product lines.
Sales reps can use it to track conversions or quotas. You can also leverage it to encourage alignment between sales and operations. While sales growth is tied directly to business scale and profitability, it's critical to understand the reasons behind both negative and positive sales growth.
Measuring and monitoring these seven KPIs can help your executive and management teams determine what your company is doing well as well as identify the areas of the business that need to improve. But do keep in mind, identifying which KPIs are right for your business will depend on several key factors--your company's business model, goals and specific operating processes.
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