Our Take

on Financial Metrics

 Our Take on Financial Metrics The literature typically calls them KPIs, or Key Performance Indicators. I used to call them Critical Performance Factors, or CPFs, before the idea became popular and in every consultant’s toolkit. Whatever you call them, the financial KPIs should be collected and reported in a dashboard format, an essential addition to your monthly financial reporting package (if not needed even more frequently). Ideally, they’ll be presented in graph or chart form for easy absorption by the nonfinancial readers.

I’ve listed below the 10 KPIs we think are most important for nearly every business. That qualifier means, for example, you don’t calculate Inventory Turnover if you run a services business that doesn’t maintain a material amount of inventory, and you don’t need a Debt Coverage Ratio if you have no debt. Just a little common sense will weed those out.  As for those that apply to your company, you will be amazed at the insights you’ll get if you capture, report, and look at these regularly. OK, enough generalization, here’s my list:

1.Gross Profit Margin – Knowing the dollars of gross profit is good, but knowing the percentage of every sales dollar that drops to gross profit is even better, because it helps you see if direct costs are eating away at your profits in not-so-obvious ways.

2.Net Profit Margin – This is a no-brainer, for sure. What percent of every sales dollar are you keeping as bottom-line profit? Again, remember that operating expenses can eat up a lot of profit if we’re not watchful, and percentages keep us alert when the numbers don’t.

3.Current Ratio – Easily gleaned from your monthly balance sheet, this is a quick way of seeing if your current assets are enough to cover your current obligations. Any ratio close to 1:1 is a problem. If you don’t have inventories the equivalent metric is called the Quick Ratio. If you’re spending time pleading with creditors or bugging customers, this is likely why.

4.Operating Cash Flow Ratio – This ratio of cash flow to current liabilities helps you keep aware of your ability to pay bills as they come due without strain, a refinement of the Current Ratio and Quick Ratio that gets down to actual cash in the bank, without having to figure out how your receivables and inventory will turn into cash when the bills come due.

5.Days Sales Outstanding – How much of your sales is still tied up in receivables? If your terms are 30 days and your DSO is 60, 75 or more, you have a collection problem.

6.Accounts Receivable Aging – Knowing your DSO is important, but receivables past due 90 days and those past due 45 days figure into your DSO equally. So to have the complete picture, what percentage of your total AR is actually 40, 60, or 90 days past due? That can be an eye opener, and should always accompany the DSO calculation for a complete picture.

7.Cash Conversion Cycle – How many days does it take for a dollar paid for inventory to come back to you as a collected sale? Remember there is buy it, pay for it, sell it, and collect the money. This will tell you something about the adequate capitalization of your business. Elements of the calculation include your AP cycle, the average days you hold inventory, and your DSO.

8.Debt Service Coverage Ratio – If you have a bank loan, your bank almost certainly follows this, and requires it to be at a certain minimum. You should follow it too, especially if you’re in a low margin business. Don’t let your bank surprise you.

9.Firm Order Backlog – How much business is on your books for future delivery? If you have to make what you sell, or buy it from overseas, there are lead times to consider. Not to mention the anticipated trend in sales in the upcoming months. If this is dropping, look out!

10.Return on Equity – If you’ve considered retiring or just selling the business, this is your first step in seeing what an outsider will want to see. How much are you earning, as a percentage of what you’ve invested over the years, will tell you something about your ability to get out of the business what you put into it. It also tells an outsider what they should expect if the business were theirs. Far from the whole picture, but it’s a good start.

And now the kicker – your dashboard should chart each of these KPIs over time – for 6, 9, or 12 months, so you can see the trends developing before a leak turns into a gusher. Lots more details in Ch. 7 of my book if you want to read further.