How to use Key Performance Indicators (KPIs) to review your company’s mid-year financial performance
July is a great time to take stock of how well your company is performing. With six months to go until year’s end, you have time to make adjustments to meet your 2019 financial goals.
To track your results, examine the key financial metrics most important to your major goals. We list several common KPIs below. You may not want to track all we discuss in this post. Use the metrics most relevant to your situation. If you need help establishing your KPIs, please contact us.
Here are 10 financial Key Performance Indicators (KPIs) you can use to track your firm’s financial progress.
1. Profit and Loss
The profit and loss (P&L) statement is a simple and very effective measure of success. The P&L gives you a summary of your company’s revenue, costs, and expenses incurred for a specific period. You can look at your P&L on a monthly, quarterly, semi-annual or annual basis.
When you review your P&L, you can determine how you spent your cash. Review the percentage each expense takes of your total budget. Determine if your spending is on track with your budget.
In your accounting system, you can run a month-by-month P&L report. This report allows you to spot what months show the lowest income and make plans to reduce spending in those months.
2. Operating Cash Flow
The Operating Cash Flow (OCF) shows the total amount of money your company takes in on a daily basis. The OCF adjusts your firm’s net income by adjusting it with items such as depreciation, changes in accounts receivable, fluctuations inventory, etc.
You can use the OCF to project your company’s ability to achieve positive cash flow. If you project a deficit in your cash, look for ways to handle the shortfall. For example, you could work with vendors to extend the financing for inventory or seek external financing. In a previous blog post (NOTE LINK TO POST), we provided tips on handling cash flow problems.
3. Working Capital
Accountants call the cash you can readily access “working capital.” You compute your working capital by totaling your current assets and subtracting your current liabilities.
In this metric, typical current assets include items such as cash, accounts receivable, inventory, and any short-term investments. In this indicator, the firm’s current liabilities usually include items such as accounts payable, deposits from customers, and accrued expenses.
Companies use this KPI to gauge how easily the business could cover short-term financial liabilities with available funds.
4. Accounts Receivable Turnover
The accounts receivable (A/R) turnover is a KPI that shows the rate at which your company effectively collects its payments due from customers. You calculate A/R turnover by dividing your total sales for a period (such as a quarter) by your firm’s average A/R for that same period.
You should measure this KPI over time. The A/R turnover helps you see when customers are starting to take longer to pay. You can use A/R turnover to flag A/R problems you need to address to get your receivables collected within the ideal timeframe.
5. Current Ratio
This KPI reveals how easily a company can pay its financial obligations in one year. You calculate your current ratio by dividing current assets by current liabilities. You state this ratio in a numeric, for example, 3 (not a decimal format).
A current ratio of three means the company has three times more current assets than current liabilities. Firms with a higher current ratio have a stronger current financial footing.
A very low current ratio may indicate a company needs to liquidate assets to pay current liabilities. In this case, the firm is not making enough money to support activities or it needs to tighten up its A/R collection strategies. For more information, visit our post on improving A/R collections (NOTE: LINK TO POST).
6. Debt-to-Equity Ratio
With the debt-to-equity (D/E) ratio, you can determine the company’s financial leverage. To calculate D/E you divide your firm’s total liabilities by your shareholder equity (or net worth).
This KPI reveals how well your business is funding your growth and how well your company makes the most of your shareholder’s investments. If your firm has high D/E, you may be paying for growth by accumulating too much debt.
7. Quick Ratio
Financial experts often call the quick ratio the acid-test ratio, named after the nitric acid test used to detect gold. You calculate your quick ratio by comparing the total amount of cash (plus A/R and marketable securities) to your current liabilities.
This KPI measures your company’s ability to use near cash or easy-to-liquidate assets to retire current short-term liabilities quickly. This metric shows your company’s wealth and its financial flexibility. The quick ratio is an easy way to assess your firm’s financial health.
Financial experts consider the quick ratio to be more conservative than the current ratio. In this ratio, you only consider quick-to-liquidate assets (not all assets). Like the current ratio, you compute the quick ratio as a numeric number, not as a percentage.
8. Income by Customer (% and $)
This KPI will reveal which customers bring you the largest portion of your total revenue. Most companies find that 20% of their customers bring in 80% of their revenue.
In addition to revenue by customer, you should also evaluate profit by customer. Make sure you can track the amount of income and expenses you derive from each client.
Once you identify your top customers, you can use that information strategically. You can develop plans to nurture these best customers. Make sure your customer-care team works to keep this group happy. Schedule regular “thank you lunches” and ask for feedback on how to improve service to them. This is also a great group to tap for referrals for new business.
For business growth, carefully evaluate the characteristics of your top customers. You may discover your best customers have similarities in size, industry, need, etc. This can help you create a profile of your best potential customer.
9. Revenue by Service
As with knowing your top customers, understanding your top services can help you grow a more profitable business.
To create this KPI, you will need to track sales by service, if you sell multiple services. If you track this metric, you can make strategic decisions about how best to expand your business.
Don’t look at revenue alone. You must also consider the costs of delivering the service. Many companies with great revenues have gone out of business because their services did not generate sufficient profit.
To track this metric, make sure your accounting and invoicing system allows you to specify which services each customer purchases. Also, make sure you can track expenses by service.
On a quarterly basis, you can run a report to calculate your total revenue, expenses and ultimately profits for each service area.
10. Customer Satisfaction (especially the top 20%)
Budget-related KPIs are important, but they are not the only metrics you should track related to the health of your business. Another metric to consider is customer satisfaction. You can gauge customer satisfaction by conducting regular customer surveys. If you provide your services by task, you could do a follow-up phone call after each task.
You can also take top customers to lunch and ask some probing questions related to their satisfaction. For example, you might ask how you could improve your service to them.
To get very candid responses from clients, some companies engage a third party to survey customers. Many folks are reluctant to express negative feelings. Make sure you have a way to determine if a top customer is not satisfied. After they decide to hire a different service provider, it’s too late to try to fix their dissatisfaction.