If you were to be asked to gauge the performance of your business today using some verifiable metrics, would you be able to?
If you would, well and good – but if, like most business owners and CFOs you’ll need some time to gather that info up cruising through tons of financial records, then you’re not alone.
Most businesses believe that the only measure of success is the very obvious; a decent stream of clients, massive revenues, and perhaps, no overdue debts. I agree, these are great measures of a business success, but there’s more to businesses than just revenue and timely payment of bills.
A good measure of the success of any business should reflect the most important key performance indicators (KPIs). We’ll discuss a few of these later on in this post but for now, let’s understand the meaning of KPIs.
Key Performance Indicators (KPIs) are measures used by businesses to gauge how effectively they are achieving their objectives. Financial KPIs are made up of revenue, profitability, liquidity, among other ratios and metrics.
Here are a few ratios that can help CEOs, CFO, and management to gauge the performance of a business.
This is one of the most important financial metrics used to gauge a company’s performance. As a major KPI, revenue indicates the amount of money received from the sale of a product or a service. An increase in the revenue/sales figure shows a high demand for your product/service while the vice versa shows a lower demand for the same. This metric can help you to gauge when to strategize to increase sales accordingly.
Gross Margin Ratio
This ratio compares the gross profit margin of a company to its net sales. The ratio is used to measure how profitable a company sells its merchandise.
The ratio is represented by the formula: Gross Margin/Net Sales
The gross margin is computed by subtracting the cost of goods sold from the Net Sales. The Net Sales are represented by the Total Sales less any refunds/returns.
Pre-net Tax Profit Margin
The pre-tax profit margin is one of the most fundamental metrics used to measure the profitability of a company after all expenses except taxes are deducted.
The ratio is calculated as Net Profit before tax/Total Sales
A higher margin or higher net profit indicates that the company is operating on minimal expenses or contains a good product/service profit margin. The vice versa indicates that either your profit margins are low or your expenses are too high to be sustained by the current revenues.
Accounts Payable/Receivable in days
The Accounts payable ratio in days shows how long it takes a company to settle its creditors, a lower number of days shows that a company has a good credit history and settles its obligations when they fall due.
The formula for Accounts Payable ratio in days is denoted by (Ending Accounts Payables ÷ Cost of Sales)/No of days (i.e 365 days in a non-leap year)
On the other hand, Accounts Receivables in days shows the number of days it takes for your customers to settle their invoices. Again here, you want to make sure that the ratio reflects as minimum days as possible to enable the business to remain afloat.
The metric is represented by the ratio: Accounts Receivable ÷ Annual Sales)/No of days (365 in a non-leap year).
This ratio shows how liquid a company is; in other words, it indicates the ability of a company to settle its day to day debts such as payment for supplied goods or services.
The Current Ratio is denoted by the formula Current Assets/Current Liabilities
The higher the ratio, the better for a company; but essentially, a ratio of 1 is considered to be safe. Meaning, there are enough current assets to settles current liabilities.
That notwithstanding, it is always recommended to strive for a higher ratio.
Ratios, metrics, and balanced scorecards help businesses in a lot of ways. Let’s look at some of the ways they benefit businesses.
Importance of Balanced Scorecards to Businesses
I hope you found this article useful, in case you have any questions or comments, feel free to drop them in the comments section or directly to us via our contacts.