You may have a gut feeling that your business is humming along smoothly — and you might be spot on. But there is no substitute for concrete numbers when it comes to measuring your business’ financial health. That’s where financial KPIs — key performance indicators — come in.
KPI is a blanket term for the types of markers that businesses use to measure performance in a variety of areas, from marketing to HR to finance. Keeping close tabs on your small business’ financial performance is essential to long-term success. These five financial KPIs will help you answer the question: Is my business meeting its goals?
1. Gross Profit Margin
Your gross profit margin tells you whether you are pricing your goods or services appropriately. Here is the equation to calculate this:
Gross profit margin = (revenue – cost of goods sold)/revenue
Your gross profit margin should be large enough to cover your fixed (operating) expenses and leave you with a profit at the end of the day (see #2 and #3, below).
2. Net Profit
This is where the rubber hits the road. Your net profit is your bottom line — the amount of cash left over after you’ve paid all the bills. You can figure out your net profit using simple subtraction:
Net profit = total revenue – total expenses
For example, if your sales last year totaled $100,000 and your business expenses for rent, inventory, salaries, etc. added up to $80,000, your net profit is $20,000. If you are a sole proprietor, your salary or draw will come out of your net profit, so it’s vital that this amount be enough to cover your personal needs plus enough extra to build reserves that can keep your business operational during slow periods.
Financing is also a possibility to help smooth out seasonal fluctuations. Many companies go this route to keep things moving during the down season.
3. Net Profit Margin
Net profit margin tells you what percentage of your revenue was profit. The equation is simple:
Net profit margin = net profit/total revenue
In the example above, your net profit margin is 20 percent. This metric helps you project future profits and set goals and benchmarks for profitability.
4. Aging Accounts Receivable
If your business involves sending bills to customers, an accounts receivable aging report (most likely a standard report in your accounting software) can be eye-opening. If customer A consistently pays her bills within 15 days, while customers B, C, and D drag their payments out to 90 or even 120 days, you may have found a root cause of your business’ cash flow problems. It could be time to start charging interest on overdue accounts or let go of slow-paying clients.
Invoice financing is also an option that can help you capitalize on outstanding invoices.
5. Current Ratio
This accounting term describes the ability of a business to pay its bills. It can be calculated like this:
Current ratio = current assets/current liabilities
The resulting number should ideally fall between 1.5 and 3. A current ratio of less than 1 means you don’t have enough cash coming in to pay your bills. Tracking this indicator may give you advance warning of cash flow problems, especially if your current ratio dips into the danger zone between 1.5 and 1.