- What are Financial KPIs?
- Why are Financial Metrics and KPIs Important?
- What are the Categories of Financial KPIs?
- Top 15 Financial Metrics and KPIs in 2021
- Which Financial KPIs and Metrics Are Right for Your Business?
Your business venture's financial condition acts as one of the pivotal characters while crafting your entity's success story. If you fail to sustain control over your finances, you eventually lose control over your entire business. Reports suggest that more than 29 percent of newly incepted entities fail due to a lack of financial resources and sound fiscal management tactics. To avoid such consequences, you must promptly keep a tab on your business concern's financial pulse.
In the past year, the unprecedented advent of the COVID-19 pandemic has led to an economic downturn on a global scale, exacerbating financial challenges for many business ventures. This situation has led to a pressing need for business owners and management teams to monitor the financial constituents of their overall entity adeptly. Overviewing the critical financial performance indicators from time to time assures that you hold the reins of such critical situations. Evaluating your business financial well-being becomes more intelligible with the inclusion of adequate financial KPIs and metrics.
What are Financial KPIs?
Financial Key Performance Indicators (KPIs) represent metrics that business entities employ to gauge their economic and operating functioning status. Businesses derive such KPIs from a financial vantage point with valuable business data such as cash flow, inventory, sales, number of employees, and much more. Many financial KPIs form part of the financial reports companies share with their stakeholders for showcasing their crucial operational and financial details for a given period. These KPIs are usually in the form of ratios that showcase correlation between different instrumental financial indicators.
Why are Financial Metrics and KPIs Important?
The analysis of financial metrics or KPIs can benefit your business in multiple ways:
- They provide a snapshot of the critical financial aspects of your business
- Such KPIs enable business management teams to take timely corrective measures
- These metrics assist in ensuring the long term financial well-being of your entity
What are the Categories of Financial KPIs?
Professionals usually classify the numerous KPIs into five main categories. Generally, the categorization of financial metrics occurs according to the type of financial data they are based upon during their estimation. The main categories include:
- 1. Efficiency KPIs
- 2. Liquidity KPIs
- 3. Profitability KPIs
- 4. Leverage KPIs
- 5. Valuation KPIs
Top 15 Financial Metrics and KPIs in 2021
The years 2020-2021 have proved to be financially strenuous for many business firms. We have highlighted some of the top financial metrics and KPIs for the current year. They can be helpful for owners and financial management teams to navigate their business on the right track.
1. Current Ratio
The current ratio is one of the essential metrics used to analyze the liquidity position of a business in the short run. Thus, it is a type of liquidity KPI. This financial KPI showcases the ratio between the current assets and current liabilities of an entity.
Current Ratio = Current assets / Current liabilities
Current assets include inventory, accounts receivables, and bank balances that you can turn into cash within the time frame of a year. At the same time, current liabilities cover dues payable in a year like short-term loans and accounts payables.
The ideal current ratio is 1:1. If the value goes below 1, it can signal that the business does not have sufficient assets in the short term to fulfill its current liabilities.
2. Gross Profit Margin
This profitability KPI outlines the profit-generating capabilities of the business. Financial experts use this metric to gain profitability trends of a company and decide the necessary course of action. You can estimate this metric using the gross profit earned divided by the net sales of a given period. For deriving the gross profit, subtract the COGS (Cost of goods sold) from the net sales. The COGS refers to the directly attributable cost of manufacturing a product or delivering a service for any business. The net sales figure indicates the total sales a company makes in a given period reduced by the returns from customers.
Gross Profit Margin = Net sales - COGS / Net sales * 100
The gross profit margin is helpful in the intermediate stage of the business cycle. It helps to understand whether the products offered are profitable for your company or not. You can also assess if your entity can mitigate the direct production costs with the sales generated in the initial phases.
3. Accounts Payable Turnover
The payment due to the suppliers of a business entity remains a source of stress for its management team. If one does not ensure timeliness in payment to creditors, they may have to pay interest and late fees. Thus, the liquidity KPIs like accounts payable turnover enlighten us about the pace at which a business pays the dues to its suppliers.
Accounts Payable Turnover = Net credit purchases / Average accounts payable for the period
Average accounts payable is computed using the average of the opening and closing balances of the accounts payable of the company for a given period (commonly a year). A reduction in the accounts payable turnover is possibly a sign of cash flow issues in your entity.
4. Inventory Turnover
Another essential financial metric, inventory turnover, measures the number of times a company manages to sell its average inventory balance, typically in a year. A type of efficiency KPI enables financial teams to make calculated decisions about manufacturing, purchases, and marketing.
Inventory Turnover = COGS (Cost of goods sold) / Average inventory in a given period
A higher inventory turnover represents more robust sales and lower hoarding of inventory. However, it should not be too high as then it can showcase the business's inability to maintain sufficient inventory to cater to customer demands.
5. Fixed Assets Turnover
A business venture uses this financial metric to judge its capability to increase sales using the investment in fixed assets. Entities who tend to make considerable investments in fixed assets like heavy equipment and machinery to enhance sales can gain pragmatic insights using this metric about their investment.
Fixed Assets Turover = Total sales / Average fixed assets for a given period
You calculate the average fixed assets using the average of fixed assets' opening and closing balances for the period as available in the financial records. A low fixed assets turnover suggests inefficient use of fixed assets in the business.
6. Debt-to-Equity Ratio
This financial metric measures your business entity's total debt against its overall shareholder's equity. Borrowings are a common phenomenon for most businesses. However, if the loan amount exceeds a particular level, your company can face unwanted risks. The total debt computation includes long-term as well as short-term debt.
Debt-to-Equity Ratio = Total debt / Total balance of shareholder's equity capital
An increased debt to equity ratio usually means that the business is leveraged more than the appropriate levels. In such cases, its management should ensure that the company earns sufficient profits to cover its debt repayments.
7. Accounts Receivable Turnover
The collection of customer payments on time is equally essential as timely payment of supplier dues to maintain working capital efficiency. Using the financial KPI of accounts receivable turnover, we can ascertain the effectiveness of a business entity in the collection of receivables promptly. You come to know about the number of times the average receivable balance gets converted to cash in a given duration.
Accounts Receivable Turnover = Net credit sales / Average accounts receivable for the given period
Entities desire a higher accounts receivable turnover as it showcases faster collections, thus a better cash inflow in the business.
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8. Gross Burn Rate
This financial KPI especially proves useful for companies that are incurring losses. In the present pandemic scenario, where many entities face losses, this metric can help gain practical insights.
This rate reflects the pace at which a venture utilizes its cash reserves to fund its operating expenditures.
Gross Burn Rate = Cash balance / Operating expenses in a month
If you have an elevated gross burn rate, it signifies that your entity is depleting its cash reserves at a faster pace. In such situations, unless you gain additional funding, you can face a severe financial crisis.
9. Earnings Per Share (EPS)
One of the decisive financial KPIs for the stakeholders of a company, this profitability metric denotes the income one can derive for every share held of a publicly listed company. There is more than one way of computing EPS.
Earnings Per Share = Net income / Weighted average number of shares outstanding during the given period
We estimate the weighted average number of shares outstanding as per the shares available at different points in time throughout the reporting period. Using a weighted average figure instead of the outstanding shares at the end of the period lowers the chances of manipulating EPS. Most investors favor companies with high earnings per share.
10. Interest Coverage Ratio
This solvency KPI is another metric for financially struggling ventures, particularly in the current pandemic era, to assess their capacity to meet debt obligations. Companies have contractual liabilities to pay interest on loans and bonds. Thus, this ratio compares the profits of a business with its interest expenditure.
Interest Coverage Ratio = EBIT / Interest expense
A higher interest coverage ratio depicts a more favorable position of the company to cater to its interest obligations.
11. Payroll Head Count Ratio
Another unique financial KPI, this metric helps appraise the human resource team's efficiency in your business organization. You can gather insights about the number of full-time workers supported by the payroll staff.
Payroll Head Count Ratio = HR team headcount / Total number of company headcount
This efficiency KPI can help business entities make crucial strategies about their overall workforce and managing their payroll team. It is particularly pragmatic amidst the scenario of financial crunch caused due to the pandemic where businesses may need to take employee retrenchment decisions.
12. Operating Cash Flow Ratio
Business organizations use this liquidity KPI to realize the ability of a company to pay for its short-term obligations with the cash flow from its primary operations. You use the operating cash flow figure available from the cash flow statement of a company to derive this metric.
Operating Cash Flow Ratio = Operating cash flow for the given period / Current liabilities
It helps to evaluate the actual liquidity position of a business as the operating cash flow gets estimated after removing the impact of non-cash operating expenditures.
13. Working Capital
A fundamental metric to ensure a streamlined functioning of the day-to-day business, working capital is a popular financial KPI. It helps determine a firm's liquidity position by showcasing the excess of its current assets over its current liabilities.
Working capital = Current assets - Current liabilities
Businesses must target maintaining an optimal level of working capital. If the working capital is negative, it might indicate its incompetency to pay its current dues. Contradictorily, excess working capital suggests a lack of optimal utilization of fixed assets.
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14. Break-Even Point
In common parlance, the break-even point refers to the point of no profit and no loss for a business, i.e., when the overall earnings and costs stand equivalent.
Break-Even Point = Fixed costs / Gross profit margin
As per Cost accounting principles, break-even analysis helps determine the level of operations a business entity has to achieve to recover its fixed costs.
15. Return on Investment (ROI)
The comprehension of financial KPIs and metrics stands incomplete without a peek into the concept of return on investment (ROI). It signifies the number of monetary returns generated from an investment proposition in comparison to its cost. You can estimate the return amount using the difference between the present worth of the investment and its cost of acquisition.
Return on Investment = (Current investment value - Cost of investment) / Cost of investment
ROI eases the process of evaluation of different investment proposals. You can derive the returns generated through a given investment over a specific time frame and determine suitable future investment decisions.
Which Financial KPIs and Metrics Are Right for Your Business?
As several types of financial metrics and KPIs exist, you need to handpick the most suitable ones for your business. The KPIs available in the finance realm vary in nature and applications. Some KPIs like quick ratio and working capital are quintessential and find applicability for all types of organizations.
On the contrary, the utility of other financial KPIs varies with the nature of business and its industrial sector. The selection process for financial KPIs remains contingent upon factors like the operating processes, business targets, and the nature of products or services offered. Thus, it would be best to self-evaluate your business conditions and goals before choosing the set of financial metrics and KPIs.
Financial KPIs and metrics form part of some primary tools finance professionals entrust to attain a clearer picture of the state of an entity's finances. These KPIs are easy to compute and support a better decision-making process. Apart from the top financial metrics and KPIs enlisted above, business entities can tailor some financial metrics to their specifications. Choose the ideal set of financial KPIs for your company and start the journey towards attaining your fiscal goals.