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Financial Key Performance Indicators: How Can They Help Your Business?

man analysing financial key performance indicators

Key performance indicators can be used to analyse most business functions. Here we’ll examine the top financial key performance indicators (KPIs) and how to use them.

What are financial KPIs?

Financial key performance indicators are values that you can use to measure business financial performance, including revenue, profits and growth. When you know how to calculate important financial KPIs, you can better understand where your business stands and what needs to be done to improve it. They make it possible to create benchmarks and goals for improvement.

1. Working Capital

Working capital is one of the main challenges for small business in Australia. It measures your company’s liquid assets, such as cash, accounts receivable, inventory, and raw materials in relation to your current liabilities, such as accounts payable. The working capital formula is: 

Working Capital = Current Assets – Current Liabilities

When you measure your working capital regularly, you can see how much money you have to cover the money you owe in the short term. At times, many Australia businesses have negative working capital, meaning they owe more than they currently have on hand. Working capital loans are one way to overcome this shortage.

2. Current Ratio (Working Capital Ratio)

The current ratio puts your working capital in a ratio that shows how able you are to cover current expenses. The current ratio formula is:

Current Assets/Current Liabilities

A good working capital number is usually between 1.2 and 2.0. Anything below 1.0 is considered to be negative working capital. If you go higher than 2.0, it shows that you aren’t leveraging your assets to maximise your revenue. Learn more about working capital and how this key performance indicator is connected to the financial health of your business.

3. Operating Cash Flow

This performance measure shows how much total cash is generated through business operations. Operating cash flow measures how much cash is generated from normal operations, so not all income and expenses are used to measure it. For example, income from selling shares or business property isn’t used to determine operating cash flow. In addition, the formula for operating cash flow is:

Operating Cash Flow = Operating Income (revenue -cost of sales) + Depreciation -Taxes +/- Change in Working Capital

Operating Cash Flow is also expressed as Total Revenue -Operating Expenses 

In effect, operating cash flow is the cash version of your net income. It focuses on the cash inflows and outflows that are connected to your main business activities, including sales, buying inventory, and paying wages. 

Learn more about this key performance indicator in What Is Cash Flow?

4. Return on Investment (ROI)

ROI measures the gain or loss from an investment as a percentage of the money that was invested. You can use return on investment to compare business investment options. The formula is:

ROI = (Net Profit/Cost of Investment) x 100

Return on investment can be used for many types of investment opportunities, such as purchasing inventory, running a marketing campaign and buying equipment. Use the Moula ROI Calculator to estimate your return on investment.

5. Return on Assets (ROA)

This ratio shows how well your assets generate income. It shows you how effective you are at managing assets. ROA will depend on the type of assets you have and your industry. The formula is: 

ROA = Net Income ÷ Value of Total Assets

6. Gross Profit Margin

With this financial KPI, you determine how much money is left in your business after you have subtracted the cost of goods sold (COGS). The formula for gross profit margin is: 

Gross Profit  = Revenue − COGS

Gross Profit Margin = Revenue − COGS/Revenue

Your gross profit margin needs to be large enough to cover your operating expenses which are not directly connected to the cost of your product or service.  Gross profit margins vary between industries. Learn more about the gross profit margin.

7. Net Profit Margin

This key performance indicator shows how much money you have taken in is profit in percentage terms. Net profit is how much money is left after you pay expenses associated with delivering your products and services, all other operating expenses, and interest and taxes. Once you have calculated net profit, the net profit formula is:

Net Profit Margin = Net Profit/Total Revenue

You can use your net profit margin as a benchmark to track how much you are keeping after you pay all your expenses. As with the gross profit margin, determining what’s good a good number will depend on the type of business you are in. Get more information on net profit margin

Both gross profit and net profit are found in financial reports, so you can calculate this financial key performance indicator for publicly traded companies.

8. Acid Test Ratio

This is an effective ratio to uncover whether you have enough liquid assets to cover your what you currently need to pay (current liabilities). The formula for the acid test ratio is:

Acid Test Ratio = (Cash + Accounts Receivable + Short-term Investments) ÷ Current Liabilities

Since it doesn’t include assets that are not liquid (such as inventory) it gives you a true picture of how well you are able to meet current liabilities.

9. Accounts Receivable

This is a simple but important financial key performance indicator that feeds into other KPIs, particularly ones that include current assets. This applies only to businesses that offer terms to their customers, usually 15 or 30 days. Knowing what you are owed at a particular point in time will give you an indication of how much money you will have coming in the near future. Accounting software programs automatically update accounts receivable but many small businesses don’t use this accounting software.  According to the Australian Small Business and Family Enterprise Ombudsman (ASBFEO), up to 45 per cent of small businesses don’t use accounting software to keep up-to-date financial records. 

Learn more in How to Collect Late Payments and Avoid Bad Debt.

10. Debtor Days

If you offer invoice payment terms, you want will want to track how long it takes you to get paid. Research conducted by Moula uncovered that 65% of SME customers don’t pay on time. Debtor days is a way to measure the average time it takes to get paid after the invoice date. The variables used in the debtor days calculation are accounts receivable and annual credit sales. The equation for calculating debtor days is:

(Average Accounts Receivable/Annual Credit Sales) x 365 days

For example, if a company’s annual credit sales are $300,000 and its average accounts receivable are $30,000, its debtor days are 36.5. In this case, if the company’s payment terms are 30 days, it gets paid 6.5 days late on average. But if its payment terms are 15 days, it gets paid 21.5 days late on average. Since this key performance indicator is in the form of a ratio, it’s also called the debtor days ratio.

Find out more in What Are Debtor Days and How to Calculate Them?

11. Accounts Payable

As the opposite of accounts receivable accounts payable shows what you owe in the near term. Unlike accounts receivable, accounts payable won’t automatically be updated in when you receive an invoice. For this reason, invoices should be updated in accounting programs as they are received. This will make it possible for you to know what your short-term liabilities are. When you don’t know what your current assets and liabilities are, you won’t be able the other KPIs summarised earlier in this article.

Learn more about financial ratios

Financial ratios can be a powerful tool for analysing the health of your business. Find out more in How Financial Ratios Can Help You Measure Your Business Performance.

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All the thoughts, ideas and musings from the Moula team! Covering everything from work/life balance to general finance tips plus everything in between!

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