The eight KPIs every business should monitor
The essence of a key performance indicator is that it is just that — key. This means that there should be just a few, and we should pay a lot of attention to each of them.
The trick is to choose well. According to PWC, between four and ten KPIs are a good amount to monitor for most companies. The chosen KPIs should give most businesses a great understanding of their financial situation and allow for informed planning.
Gross Profit Margin
= (Revenue - Cost of Sales) / revenue * 100
Gross profit margin is a measure of profitability without accounting for overheads. This KPI is most useful for products or portfolios, allowing comparisons without having to estimate their requirement for overheads.
Net Profit Margin
= Net Profit / Revenue * 100
Net profit margin measures profit but considers all the business's fixed costs.
= Current Assets - Current Debt
Working Capital is all the available liquidity you can use for day-to-day operations such as payroll, debt repayment, and account payables.
= Current Assets / Current Liabilities
The current ratio measures liquidity to ascertain that the business can pay any obligations within the year.
= Total Assets / Total Equity
Financial leverage measures risk to the business by calculating how much of the business assets are financed by debt. The bigger the number, the riskier the business.
Debt to Equity Ratio
= Total Debt / Total Equity
The debt-to-equity ratio also measures risk in the business by seeing the ability of equity to cover all debt should a business downturn happen.
Return on Equity (ROE)
= Net Profit / (Beginning Equity + Ending Equity) / 2
ROE indicates how well the business can use investments of its assets to generate a profit.
Operating Cash Flow
Operating cash flow measures how much cash a business is generating. Positive cash flow can grow operations, whereas negative cash flow requires additional financing to keep the lights on.
See here for a more exhaustive list of Finance KPIs.
Implementing a system for tracking and reporting on KPIs
Follow this list to implement financial reporting in your business.
- Define and agree on the KPIs you will be tracking**
First, consider what KPIs you want to track rather than starting with what is possible. Otherwise, we risk ending up in "KPI soup" and tracking and reporting on a wild number of KPIs, leading to confusion, lack of insight, and inaction.
To pick what KPIs to track, you need to consider each KPIs' role in decision-making. Profit measures are useful because they point to imbalances between expenses and income.
For example, a very low net profit margin should raise questions about the current costs of overheads and whether it's possible to reduce them for a healthy margin.
On the other hand, debt-to-equity ratios might be something you can calculate once a year. Pay little attention if, for example, the business doesn't significantly rely on debt to finance its operations.
In defining the KPIs to track, monitor, and report on, you must involve all stakeholders to ensure everyone is happy with their insight into the business performance.
- Agree on the frequency of reporting
Once you understand the ideal scope of tracking and reporting, consider the frequency on which the finance function reports to the business.
The reporting, of course, may happen at various levels and at various intervals.
The CEO might be interested in monthly (or even more frequent!) reporting of various KPIs. However, board members will not need constant reporting.
Companies that are transparent about the business's health have happy employees who feel they understand their contribution to the bigger picture. It's increasingly standard for finance teams to communicate with the wider business on key performance indicators, especially profitability measures.
Consider quarterly, town hall-style meetings to communicate with everyone in the organization, whether it's great, good, or not-so-good news.
- Pick a system for tracking KPIs
Depending on the nature and maturity of your business, you might be able to track and monitor KPIs with Spreadsheets and Business Intelligence tools such as Microsoft BI and Google Data Studio or in combination with your accounting software.
Accounting software will automate some of your tasks, such as payroll and tracking invoices and income, so that calculating profit, liquidity, and solvency is easy.
However, most finance KPIs are based on calculated metrics, which means you will need to draw from various sources, like your expense management software, to obtain them.
For bigger companies, Enterprise Resource Management (ERP) can be the ideal solution as it combines orders, inventory, manufacturing, and resource planning with the finance management function. Working with expense management software that directly integrates with an ERP is ideal. Having seamlessly connected data from payment to bank reconciliation can give businesses a holistic view of business health.
- Master the art of data visualization
You're only tracking KPIs because you have an audience that needs to know, and finance teams love numbers and graphs. However, a little effort in data visualization can go a long way for people who are not a day in and day out in front of data dashboards.
De-cluttering graphs and editing so that key insights are highlighted will make everyone more likely to pay attention to the reports.
- Interpreting results
Numbers tell a story, but only if you're listening and you speak the language. To interpret results, you need to be able to compare them.
You have three options:
- Compare them to your targets
- Compare them to previous performance
- Compare them to competitors
If targets have been set, you should look at this because targets have been drawn up considering the market and competitors. If targets are missing, comparing previous periods can give a sense of how well management has led the business through all its functions.
Finally, comparing to competitors, where data is available, can also be really insightful in understanding how different strategies are panning out in the competitive landscape.
- Zoom in on the real-time picture in with Payhawk
Finally, a KPI system is only complete with accurate and real-time insight into your expense management. With Payhawk, you can stay in control of your outgoings with our all-in-one spend management software. Book a demo to find out more.