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9 KPIs for understanding your business’ financial health

These 9 KPIs can be integral to your business’ growth - here’s how to make sure you’re doing it right.

Key Performance Indicators (KPIs) are a measurable value that can show if a business is or isn’t profiting, growing and reaching its objectives. These KPIs can be big or small, and will vary between different departments within your business, and the business as a whole.

KPIs are typically structured to have a measure, a target (e.g. a dollar value), a data source (e.g. a reporting system or software to track the measure), and a reporting frequency.

If you’re looking for a deeper understanding of the financial health of your business, KPIs can be a great way to identify areas of success and areas that may need improvement.

Here are 9 KPIs that you can measure to better identify the financial health of your business. 

Big-picture KPIs

Firstly, here are some KPIs a company owner will want to use to measure the overall financial health of the business.

1. Net profit

The first place a business should start when exploring its financial health is to measure its net profit. This will essentially show you if your business is more or less profitable year to year. Keep in mind that it’s not uncommon that this will fluctuate, especially if your sales are seasonal so it's often helpful to compare the same period in the previous year.

Net profit is not the same as cash received and includes some non-cash elements like credit sales and depreciation of fixed assets which spreads the cost of these assets through time. Net profit is an important measure but it's even more important to monitor cash flow closely as that's what pays the bills.

Net profit = total revenue - expenses. 

2. Net profit margin

Similar to net profit, your net profit margin indicates how much of a profit the business earns from its revenue after all expenses have been deducted. A high net profit margin may indicate your business is at less risk due to your pricing products correctly, for example, whereas a low net profit margin may show a lower margin of safety. If your sales were to decline, your profits are more likely to fall too. 

Net profit margin = net profit / revenue.

3. Free cash flow

Cash flow is arguably one of the most important KPIs for your business. This is because net profit can be misleading if a business makes a lot of sales on credit. While making a lot of sales in this way would make the accounting profit look good but, if the invoices are not being paid, there won't be any cash coming in. There is a common saying in business - "turnover is vanity, profit is sanity, cash is a reality".

Free cash flow specifically is the amount of cash a business has available after paying for its regular operations and capital expenses. Having a positive free cash flow means that your business has more money coming in than going out. Whereas having a negative free cash flow means the opposite.

Free cash flow = cash coming from operating activities - capital expenditures.

4. The cash conversion cycle 

Another KPI worth considering for your business is the cash conversion cycle. This is the number of days it takes a business to convert its inventory purchases into cash. The lower the figure, the higher the business’ operational efficiencies.

Often, a business that sells its inventory will:

  1. Finance the inventory instead of paying for it with cash upfront
  2. Keep the inventory on hand before it is sold to a customer
  3. Sell the inventory on credit instead of receiving cash at the time of sale

The cash conversion cycle quantifies the time taken at each of these steps, and returns an average number of days from when the business pays for inventory, to when it receives cash receipts from sale of the inventory.

Cash conversion cycle = Days of sales outstanding

                                            + Days of inventory outstanding

                                            - Days of payables outstanding

5. Quick ratio

Cash is king and the quick ratio is all about your access to cash. It can help to measure how easily your company could cover any liabilities from the amount of cash, securities and accounts receivable you have.

Another version of the quick ratio is the working capital ratio which also includes inventory. This can also be useful but needs to be used with caution as often inventory cannot be turned into cash as quickly as hoped.  

Quick ratio = (cash + securities + accounts receivable) / current liabilities. 

6. Gross margin ratio

For businesses selling products, a gross margin ratio can show you what money is remaining after paying for the Costs of Goods Sold (COGS). A higher gross margin ratio can mean your business has more money for expenses like admin, salaries, overhead etc.

The gross margin is often a function of the industry you are in as well as how efficient you at managing your sales price and cost of good sold. For example, Software as a Service businesses can have up to 80% gross margins as the cost of selling an extra subscription is very close to zero once the software has been built. Retailers on the other hand have very low gross margins and rely on large volumes to make money. 

Gross margin ratio = (revenue – COGS) / revenue.

Smaller-scale KPIs

Some KPIs are best measured on a smaller scale, within the various departments of your business. By stepping away from the big picture, you can then identify any gaps internally where your business may be hurting financially.

7. Marketing – call-to-action content conversion rate

Does your website have clear, call-to-action (CTA) content, such pay-per-click campaigns? A KPI that indicates the success of these CTA methods is a conversion rate. A conversion rate is the number of conversions (users who take the desired action on your page, such as clicking on a button) divided by the number of visitors.

Using tools, such as Google Analytics, you can view the number of clicks on chosen CTAs and the number of website visits over a set period of time to find the conversion rate and measure their success.  

CTA content conversion rate = conversions / visitors.

8. Sales - New contracts signed

An example of a sales specific KPI you may want to measure is the number of new contracts signed over a specific period. This may show you if your business’s client list is growing. As the name suggests, this KPI involves your sales team measuring and tracking the number of new contracts being signed in a chosen time frame (weeks/months/years).

New contracts signed = number of contracts over chosen period of time.

9. Accounts – Days sales outstanding

The days sales outstanding (DSO) KPI can help a business to see how successful it is in getting invoices paid on time. This can be a crucial KPI for small business owners who are struggling with a lack of cash flow and wondering why they can’t get their company off the ground.

The DSO will indicate how long, on average, your company’s invoices are outstanding. If this number is too high, it can indicate that there is either a problem with your accounts receivable process, or that you may need a little help from a third party through invoice financing.

If you’re considering looking at invoice financing for your small business, it’s worth considering how the different types, such as invoice factoring and invoice discounting, may help you to improve your cash flow and keep your business in the black.

DSO = (accounts receivable balance / total sales) x number of days in chosen time frame.

If you think that your business would benefit from Earlypay's easy-to-use invoice financing facility, please call 1300 760 205 or email our friendly team on hello@earlypay.com.au.