The most effective way to keep the financial standing of the business in complete control and evaluate it regularly is to set up a dashboard and monitor its KPIs. In order to make decisions regarding the profits, having only the data on income, expenditure and the total budget is not enough. To keep the financial conditions of the company under control, it is necessary to take into account many different factors. In this article, we will consider 10 of the most important KPIs which will be especial for CFOs and financial managers of the company.
This cash KPI shows the total amount of money that the organization generates through all of its normal business activities. Thanks to operating cash flow (OCF), it is possible to understand whether the company is able to maintain positive operating cash flow or if it needs external financing to cover all expenses. When calculating the OCF, it is important to compare it with the the total amount used. This makes it easier to understand whether the business is generating enough revenue to be able to maintain profits. Here is how the indicator is calculated: the operating expenses should be subtracted from the revenues and to get the value of operating cash flow.
The current ratio reflects the company's ability to cope with all of its short term financial obligations. This key performance indicator includes the company's current assets and current liabilities. At the same time, the assets also include cash and inventory, and liabilities include payables and debts. To calculate the current ratio, you need to divide the amount in current assets by the amount in current liabilities.
This metric is especially useful for investors. Using current ratio, they can determine if the business has a healthy operating cycle. For example, if the ratio is too high it shows that the company is not utilizing its assets efficiently. In addition, if the current ratio is lower than 1, then there may be difficulties paying the short-term liabilities.
With the help of this financial KPI, you can track the speed at which the company, as a startup, spends venture capital money over a certain period (weekly, monthly, or annually). This key indicator may also be useful for small organizations that do not make a detailed financial analysis. Compared to net income and revenue, the burn rate clearly demonstrates whether the operating costs of an organization are sustainable in the long run.
Gross profit margin makes it clear how much of the revenue remains after taking into account the cost of goods sold. This metric is an excellent indicator of company's profitability. If there were no radical changes affecting the production costs or the pricing policy of the company, then the gross profit margin is quite stable as a KPI. It is also easy to calculate: subtract the cost of goods sold from the revenues and divide the result into the total revenue.
Net profit margin helps measure how efficiently the business generates profits. This KPI is usually expressed as a percentage. It is calculated by dividing the company's net profit for a certain period of time by the revenue for the same period. The final figure should demonstrate what percentage of the revenue is net profit. Net income reflects the profitability of a business and reveals how quickly a company can grow in the long run. The difference between the gross and net profit margins is that the net profit margin is the remaining part of the revenue after deducting non-operating expenses and taxes.
Working capital measures the company's current assets, to see if the company can meet short-term financial obligations. The assets include cash, short-term investments, and receivables. These parameters demonstrate liquidity, i.e. business’s ability to generate cash. In fact, working capital shows the level of available cash. This KPI is especially useful if the company is looking for investment. In the case of a low or negative working capital, it becomes less probable to land investment.
This KPI calculates how much money the company is expecting to get from its debtors. Current receivables help the business estimate its expected income, and its turnover indicates the average number of days it takes to collect those receivables. If the turnover ratio of the receivables is high, then the company will most probabaly lose money.
Accounts payable are the opposite of receivables. Here we talk about the amount that the company must pay to others: suppliers, banks and creditors. This category includes bills for electricity, telephone and Internet access, as well as advertising, travel, entertainment, and stationery. It, of course, is calculated for a specific period of time. If you want to break down the the indicator into smaller parts you can calculate it by departments or projects. Thus, this KPI demonstrates how quickly a company is able to pay its payables.
Debt to equity ratio measures how effectively the company uses its equity investment. A high debt-to-equity ratio suggests that the business loses investment and accumulates debt, instead of raising capital. A lower result indicates almost complete payback to its investors. Simply put, using this metric you can find out how much debt the organization has accumulated by the time it became profitable.
This financial indicator is often confused with operating profit/loss because it is also income before interest and taxation. The difference is that when calculating earnings before interest and taxes, you should also take into account incomes and expenses that are not related to ordinary activities: other income. If the company does not have one, then the figures are identical. We need this KPI in order to have an overall picture of how the business performs regardless of its debts.
Depending on the specifics of the business, some indicators may be more useful than others. However, these particular financial indicators are universal and they are undoubtedly useful for companies with different types of activities. The most important nuance in the calculation of such indicators is being able to check the results thoroughly and make sure those are reliable. Properly calculated KPIs will not only help raise the company’s profitability but will also improve its financial performance.
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