It is essential to consider the financial performance of your company, and not just as an emergency measure in difficult economic times. Dynamic monitoring of financial KPIs boosts agility and confidence, allowing you to move quickly, take advantage of new opportunities, or retreat when difficulties arise on the horizon.
Tracking key financial performance indicators (KPIs) will allow you to anticipate the future growth of your business and direct your relationships with partners, banks, investors, suppliers, and customers. Here are the top five KPIs you should keep in mind.
1. The required working capital KPI
What is the required working capital?
The working capital requirement measures the financial resources needed to cover the gap between payments made and payments received and shows the amount of financial resources the company needs to ensure its production cycle and repayment of both debt and future operating expenses.
As a key indicator, the working capital reflects the real-time assessment of the company’s cash situation, indicating to what extent (or not) you may be facing an unforeseen event, such as late payment or non-payment.
How to calculate the required working capital?
Working capital = Inventory + Accounts Receivable – Accounts Payable
Tip: A negative working capital (less than 1) indicates that the funds spent on the company’s operations exceed the revenues from commercial activities. In contrast, a positive working capital (between 1.5 and 2) is a sign that the company does not have to consume its long-term resources to meet its short-term needs.
2. The Debt ratio KPI
What is the debt ratio?
It is the proportion of a company’s debt-financed assets. This rate measures the degree of indebtedness of the company.
It is essential to keep an eye on your company’s debt level. Armed with this information, you can look to the future and make informed decisions. For example, if the purchase of certain equipment is essential for the development of the business, you can choose to finance the purchase by taking out a new loan or by attracting new investors in the company’s capital.
These two very different strategies will each have a specific impact on your business, which means that you need to base your decisions on quantitative indicators. Debt calculation also provides you with information about your company’s cash flow and financial independence.
How is the debt ratio calculated?
Debt ratio = Total Debt/Total assets
Tip: The debt ratio, expressed as a percentage, is the ratio of total debt to total assets. A debt ratio of more than 100% indicates that a company has more debt than assets, while a debt ratio of less than 100% indicates that a company has more assets than debt.
3. Profitability threshold or Break even point KPI
What is the financial profitability threshold?
The profitability threshold is an indicator of fundamental importance, which shows you the threshold above which you will start earning money.
Although the break-even point is always set when starting a business, it is sometimes ignored once the company is up and running. However, this KPI needs to be checked regularly, as it is constantly changing, depending on various factors, from rising costs to suppliers to a higher salary bill.
How is the break-even point or profitability threshold calculated?
Profitability threshold = fixed costs / gross profit margin
Tip: The break-even point is reached when revenue is equal to total costs. Based on this indicator, you can adjust your production costs and make a faster profit.
4. The Cash Flow financial KPI
What is cash flow?
“Cash flow” refers to the cash inflows and outflows of an enterprise, generated, for example, by operations, investments, and financing. The free cash flow reflects the cash you have or the pool of funds available for use.
The cash flow forecast is based on estimates of these future cash movements. By updating your forecast on a regular basis, for example, weekly or even daily, your assessment of your future expenses and income will be closely aligned with the actual situation of your business.
How is cash flow calculated?
There are actually a couple of formulas for calculating the cash flow, from which the most important ones are:
Cash flow = Cash from operating activities +(-) Cash from investing activities + Cash from financing activities
Cash flow forecast = Beginning cash + Projected inflows – Projected outflows
Operating cash flow = Net income + Non-cash expenses – Increases in working capital
Tip: A cash flow forecast is always evolving and should therefore be reviewed regularly, preferably at least weekly.
5. Calculate and track your Profit margin for having a good overview of financial KPIs
What is the profit margin?
Represents the percentage of sales turned into profit. There are several types of profit margins. The main profit margins are:
- Gross profit margin: the difference between the proceeds from sales of products and the cost of goods sold (COGS).
- Operating profit margin: the percentage of a company’s profit from its total revenue and after the payment of variable costs, but before the payment of taxes or interest.
- Net profit margin: the percentage of a company’s profit from its total revenue and after paying variable costs and taxes or interest.
You can use these KPIs to estimate the profit generated by your company. The margin is dictated by various factors, such as the size of the company and the volume of goods produced. In general, as sales volume increases, so does the profit margin.
How is the profit margin calculated?
Gross profit = total revenue – cost of goods sold (COGS)
Gross Profit Margin = ((Revenue – Cost of Goods Sold) / Revenue) x 100
Operating profit margin = operating profit / income
Net profit margin = net profit / net income
Tip: Like cash flow forecasts, your profit margin always changes in response to a wide range of factors, from volume discounts to production costs. Tracking this KPI approximately daily will allow you to make quick adjustments.
Careful monitoring of these financial KPIs allows you to stay in control of your business and provide a solid foundation for all the strategic decisions you need to make.
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