“If you don’t know your numbers, you don’t know your business” – Marcus Lemonis
What do you think about this statement by American businessman, television personality and philanthropist – Marcus Lemonis?
If you’re like most business owners we’re spoken to at our Accounting Firm, you will agree with what Mr Lemonis stated here because it’s almost common sense that business owners have to understand their numbers.
While this is true – if we were to ask you questions about your business’s numbers, how many of our questions do you think you could answer?
Understanding the “numbers” of your business is vital to the health & success of your business. The importance of this cannot be overstated. In this guide, we’re going to look at how you can use KPIs for small business to get a better reading on your numbers & your business’s performance.
What Are KPIs? (Key Performance Indicators)
A key performance indicator (KPI) is a metric used to evaluate the success of a business or individual in achieving specific goals. We’ve found that the most straightforward way to explain the concept is to break it down into three levels:
An indicator is a measure used in your business to capture a measurement. For example, you may measure how much money your customers spend, the number of people who visit your website, or the number of times someone clicks on an ad. Indicators are often meaningless because they don’t necessarily affect your business. For example, does it make sense to know how much your customers spent during the past month? It might only be meaningful if you plan to increase your prices next month and want a number to be used for comparisons, but generally, there’s nothing actionable you can take based on that information.
A performance indicator tracks a measure related to your organisation’s performance. Manufacturing companies may examine performance indicators around the number of raw materials sourced, the number of defects per manufactured lot, or the number of steps in your manufacturing process. A performance indicator is missing one thing: Its criticality to the business.
Key Performance Indicator
Key Performance Indicators (KPIs) are the subset of performance indicators most critical to your business at the highest level of your organisation. KPIs help you measure your progress toward achieving your strategic goals.
Why Should You Track KPIs
Suppose you visit a doctor annually for a checkup. In that case, the chances are they will discuss with you, run some blood tests, test your vitals etc. and then make healthcare recommendations for you based partly on the information they’ve uncovered during those tests.
These tests are similar to KPIs: They are key indications of how healthy you are and how well your body is functioning. You might miss something important if you don’t go to your doctor for regular checkups.
It’s surprisingly easy to ignore problems brewing within your organisation’s financials, marketing, and sales without realising it. KPIs are like diagnostic tests you run on your own but for your company. Unlike your annual checkup, KPIs can be checked 24/7, weekly, monthly, or annually, so you can get results when needed.
By measuring and keeping up to date on your KPIs, you can better position yourself to make crucial decisions based on hard data. For example, suppose you’re running several different marketing campaigns. In that case, your KPIs can tell you which ones to keep running and which ones to cut short, maximising your profits and minimising your losses.
KPIs drive organisational performance and keep everyone accountable while working to achieve strategic goals.
How To Choose The Right KPIs For Your Small Business
What KPIs to measure will differ from business to business because KPIs should only measure what is critical to your business’s success at the highest level. What is crucial for success in a restaurant will differ from what is crucial for success in a manufacturing company or farming organisation.
It’s recommended that a business leadership team establish its business objectives for whatever time horizon it would like and work backwards from there to identify the KPIs and targets that need to be hit to maintain progress & achieve the goals set.
Key Financial KPIs for Small Business
While the right KPIs to track for most small businesses will depend on their unique situation, companies must keep an eye on a few common financial KPIs relevant to most businesses. Here are the most commonly applicable KPIs for Small Business.
Revenue is the total amount of income generated by the sale of goods or services related to it. Revenue is another word for the amount of money a company generates from its sales. Revenue is most simply calculated as the number of units sold multiplied by the selling price. Because revenues do not account for costs or expenses, a company’s profits, or bottom line, will be lower than its revenue.
Revenue = Sales Price x Units Sold
Expenses are the cost of operations that a business incurs to generate revenue. Examples include labour, equipment, supplies etc.
Expense categories can be divided into two broad groups: operating expenses and nonoperating expenses. Operating expenses include mortgage payments, production, and administrative costs. The non-operating expense includes things like loan fees and other lending charges.
Expenses = Cost Of Goods Sold + All Other Business Expenses
Net Profit is the money left over when subtracting all costs and taxes from revenue. Small businesses must generate enough revenue to cover their costs; if they don’t, they risk falling into financial trouble and ultimately closing down.
Net Profit = Revenue – Total Expenses
Cash Flow/Operating Cash Flow
Cash is the lifeblood of small businesses—they rely on the money coming in to pay expenses. Cash flow is money moving in and out of business over a specific timeframe. If more money comes in than goes out, a business has positive cash flow, and if it’s paying out more than it receives, it has negative cash flow. Read our article on how to increase cash flow in small business to learn more about cash flow & how to generate it on depend.
Operating cash flow (OCF) is the cash a company generates through typical operations. This metric can give a business a sense of how much money it can spend in the immediate future and whether it should reduce spending. OCF can also reveal issues like customers taking too long to pay their bills or not paying them at all.
Operating Cash Flow = Net Income + Non-Cash Expenses – Increase In Working Capital
Working capital is the difference between current assets (cash, accounts receivable and short-term investments) and liabilities (accounts payable, payroll, taxes and debt payments). This metric helps paint a picture of a business’s financial state for the near term by looking at its available liquidity to cover immediate expenses.
Working Capital = Current Assets – Current Liabilities
Budget vs Actual
Just as it sounds, budget vs actual compares a company’s actual spending or sales in a particular area against the budgeted amounts. Although budgets and expenses are related, budget vs actual can be used to compare revenue and expenses.
This “budget variance analysis” helps small business leaders identify areas of the business where they’re overspending that may need further attention. It also reveals areas of the business that outperformed expectations.
Budget Variance Percentage = Actual/Forecast – 1 x 100
Accounts Receivable Ageing
Accounts receivable ageing is a report that measures how many days your customers take to pay their bills. Companies often include credit terms on an invoice that say how many days the customer has to submit the payment; 30 days is common.
On an accounts receivable ageing report, a business typically organises clients by the due date—immediately, 1–30 days late, 31–60 days late—to see how much money is collectable from different companies and timeframes.
When accounts receivable run behind, it hurts cash flow and working capital. Businesses may need to cut ties with consistently late customers, as these delays can cause a cash flow crunch. An idea to consider is offering customers a discount for early payment to prevent delays.
Accounts Payable Aging
Accounts payable ageing is a report similar to accounts receivable ageing, except it looks at how many days your business takes to pay its bills. Like with accounts receivable ageing, a company lists its upcoming bills based on when they’re due to ensure it can meet all obligations and resolve any problems ahead of time. Revenue, cash flow and accounts receivable ageing can all affect your ability to keep up with invoices from suppliers, technology vendors and other business partners.
How quickly a business pays its bills affects its ability to get loans & capital. Businesses that can stay on top of their financial obligations can reinvest the savings from early payments into the business.
The break-even point is when revenue equals costs, meaning there is no profit or loss. Also known as the margin of safety, the break-even point helps a business know when it will earn more than it spends and start earning a profit. By calculating the break-even point, a software provider knows how many licenses it needs to sell, or a manufacturer understands how many products it must move to cover monthly costs.
Break-Even Point = Fixed Costs/(Sales Price Per Unit – Variable Cost Per Unit)
Gross Profit Margin
Gross profit margin ratio shows revenue after deducting the cost of goods sold (COGS) — the direct costs of making a product. This ratio, written as a percentage, reveals the gross profit for every dollar of revenue a business earns. For instance, a ratio of 60% means the company receives 60 cents of profit for each dollar of revenue.
Gross Profit Margin = (Revenue – COGS)/Revenue x 100
The profit margin is similar to the gross profit margin but accounts for all expenses, like payroll and other operating costs, rather than just COGS. Although standard profit margins differ between industries, many companies target a profit margin ratio of at least 25%.
Profit Margin Ratio = (Revenue – Expenses)/Revenue
Quick Ratio (Acid Test Ratio)
The quick ratio, also called the acid test ratio, measures whether a business can fulfil its short-term financial obligations by evaluating whether it has enough assets to pay off its current liabilities. The quick ratio is written as a decimal, with a ratio of 1.0, meaning a company has just enough assets to cover its liabilities.
Quick Ratio = (Cash + Marketable Securities + Accounts Receivable)/Current Liabilities
Average Cost Of Customer Acquisition
Average customer acquisition cost uncovers how much a company spends, on average, to add new customers during a certain period. This KPI factors in expenses for marketing, technology, payroll and more. What is seen as an acceptable cost of customer acquisition varies greatly depending on the industry and is influenced by many other KPIs already mentioned in this article, such as gross profit margin.
Cost Of Customer Acquisition = (Cost of Sales + Cost of Marketing)/New Customers Acquired
Cash Runway/Burn Rate
Cash runway calculates how long a company has before it runs out of cash based on its current money and how much it spends per month. This metric helps businesses understand when to cut back on spending or get additional funding. If your cash runway shortens over time, it’s a sign your company is spending more money than it can afford to.
Cash runway is closely tied to burn rate, which measures how much money a company spends over a certain period (usually monthly).
Cash Runway = Cash Balance/Monthly Burn Rate
Tracking KPIs is vital to your business. Picking the right KPIs can help you make informed decisions to grow your business. If you would like help defining your business goals and identifying your KPIs – the team of accountants in Albany, WA, from The Accounting Centre can help. We offer a complimentary first appointment if you would like to explore working with us. All you have to do is reach out by calling the number on this website, submitting an appointment request form or by visiting our Albany Accounting office.