August 8, 2022
The ability to generate income and effectively manage your Key Financial Metrics is essential for success, whether you are a Fortune 1000 company or an ambitious startup.
A PwC poll found that 56% of respondents still use manual processes and spreadsheets to maintain performance indicators, despite the development of automation tools that can manage routine daily chores and track KPIs.
It's crucial for every organization to determine which financial KPIs are most important to its operations and corporate financial performance measurements. However, the inexperienced may find finance scary.
This article aims to increase your comfort level when understanding and discussing financial metrics. Also, the article will introduce you to several Financial KPIs examples.
Financial metrics are objective measurements that are used to assess a company's performance and production. Both internal managers who want to increase productivity and external analysts who want to make choices that will affect the company use them.
Financial KPIs, on the other hand, are measurements that businesses employ to track, evaluate, and assess the financial health of the business.
For any corporate financial performance and measurement of business success, financial measurements and KPIs are crucial.
KPIs are much more effective when used to evaluate the company to other similar businesses, to assess progress versus targets, or to study patterns over time.
You can better position yourself to evaluate how the business is doing financially by understanding these data. Following that, you can make adjustments to your department's or team's goals in order to support important strategic goals.
The following metrics and Financial KPIs are among the most crucial for managers and other key stakeholders within an organization to comprehend. They are often found in the financial statements mentioned above.
1. Gross Profit Margin: This profitability metric gauges the amount of revenue that remains after deducting the Cost of Goods Sold. Is a profitability ratio that calculates the amount of revenue that remains after deducting the cost of goods sold?
In other words, the gross profit margin is a metric of profitability that is particular to a product or series of products and excludes expenses.
Formula to calculate Gross profit margin is:
Gross Profit Margin = (Revenue - Cost of Sales) / Revenue * 100
2. Net profit margin: The Net profit margin KPI gauges how well your company turns a profit on every dollar of revenue it receives. This includes both operating and non-operating costs, such as rent and utilities (like taxes and debt payments).
In contrast to gross profit margin, the net profit margin is a measure of overall business profitability that includes not only the cost of goods sold but also all other related expenses.
Net Profit Margin = Net Profit / Revenue * 100
3. Return on Equity: also known as ROE is a profitability ratio that is calculated by dividing net profit by shareholders' equity.
The return on equity calculation formula is as follows: Net income ÷ Shareholder’s equity. Your shareholders will see that you're growing your company thanks to their investments if your ROE is high or improving.
ROE = Net Profit / (Beginning Equity + Ending Equity) / 2
4. Operating cash flow: is an estimate of how much money the company generates from its activities
This metric could be positive, indicating that there is cash on hand to expand operations, or negative, indicating that further funding would be needed to keep things as they are. One of two methods can be used to determine the operating cash flow, which is often found on the cash flow statement: both direct and indirect
Operating cash flow is calculated as follows:
Operating cash flow ratio = Operating cash flow / Current liabilities
5. Current Ratio: This metric illustrates how liquid a corporation is right now. It measures how much the company's present assets are worth in relation to its current obligations.
Cash, accounts receivable, and inventory are examples of current assets that can be turned into cash within a year.
This ratio takes into consideration your current liabilities, such as account payables, as well as your current assets, such as account receivables, to assist you determine your company's stability.
Current ratio = Current Assets / Current Liabilities
6. Quick Ratio: Another liquidity ratio that assesses a company's capacity to meet short-term obligations is the quick ratio, commonly referred to as the "acid test ratio."
If an organization encounters cash flow issues, it reflects its capacity to quickly generate cash to pay its debts. Businesses frequently strive for quick ratios higher than one.
This is the fast ratio formula:
Quick ratio = Quick Assets /Current Liabilities.
7. Inventory Turnover: Inventory turnover is a measure of efficiency that indicates how frequently a company sells all of its inventory in a given accounting period.
A low inventory turnover ratio typically means that the business is buying too much inventory or that sales are weak; a higher ratio means that the business is buying less inventory or that sales are stronger. Calculating inventory turnover is as follows:
Inventory Turnover = COGS / average inventory balance for the period
8. Working Capital: The current ratio and other liquidity measurements, such as working capital, are frequently combined. It compares the company's current assets to its current liabilities, just as the current ratio.
The formula for calculating working capital is
Working Capital = Current Assets - Current Liabilities.
9. Leverage: Leverage in finance, commonly referred to as the equity multiplier, is the process of borrowing money to purchase assets.
The multiplier is one if all of the assets are financed by equity. The multiplier rises from one as debt increases, illustrating the leverage effect of the debt and ultimately raising the risk of the company.
Leverage = Total Assets / Total Equity.
10. Gross Burn Rate: This KPI is typically used by loss-making companies to track how quickly available cash is being depleted by operating costs. The gross burn rate of a company is frequently taken into account by investors when deciding whether to offer finance.
Gross Burn Rate = Company Cash / Monthly Operational Costs.
Good financial metrics should most likely give strategic decisions an objective basis and aid in avoiding the use of prejudices and unfounded rumors in business management.
Good financial metrics give business leaders the ability to concentrate on the big picture and spot any critical issues without becoming bogged down in the specifics of what's going on behind the scenes, similar to the indications and warning lights displayed on a car's dashboard.
The most important financial metric can be broken down into three key parts:
Key Financial Metrics are high-level measurements of profits, revenue, expenses, or other financial outcomes that concentrate primarily on relationships obtained from accounting data. They are nearly always connected to a particular financial value or ratio.
These measurements and KPIs should be made internally accessible to management and communicated on a weekly or monthly basis via email updates, dashboards, or reports. If they're not easily accessible, financial statement analysis can nevertheless help you familiarize yourself with the indicators.
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