In order to improve and to sustain your company’s activity, it is essential to permanently evaluate its financial and commercial health. Therefore, it is fundamental to select the appropriate Key Performance Indicators (KPI) to identify, so that the financial service can detect the strengths to build upon, and the weaknesses to optimize.
In the following article, you will find some examples of Key Performance Indicators to integrate into your reports.
The “general” financial ratios
Calculating the revenue fluctuation is most probably the most evident performance indicator to implement into your report. In fact, it will be an excellent scale to measure the company’s financial health. You can compare your revenue to your competitors’ to position yourself.
Calculation: current sales revenue/past year’s sales revenue
In addition, it may be interesting to compare your actual financial performance with what you initially planned. Hence the interest in calculating your turnover variances: this consists of subtracting your actual turnover from your forecast turnover for a given period.
By regularly comparing your actual sales and forecasts, you can effectively analyze the evolution of your business and adapt your strategy continuously. It also allows you to improve your future forecasts and set more realistic business goals.
Another example of a KPI is the added-value calculation, which allows to measure the production value of goods made by a company and to stay informed of your company’s development and activities.
It is a reliable representation and can be calculated in multiple ways:
Calculations: sales revenue – cost of production
The KPIs to analyze the end of year statement
The net working capital
The net working capital represents the resources that a company benefits from in the long-term. These resources serve as a security “mattress” destined to be used in case of a major problem: a client bankruptcy, a decreasing sales revenue, etc.
Calculation: Regular income – sustainable employment
Or: current assets – current liabilities
How to interpret working capital?
Working capital is positive:
Your business generates a surplus that allows it to cover its investments over the long term. In other words, you have a sufficient margin of financial security in terms of your cash flow.
Working capital is zero:
Your business has just enough sustainable resources to cover its long-term investments. However, it does not have a surplus to meet any short-term needs (such as working capital), which can weaken its financial security.
Working capital is negative:
Your company does not have sufficient financial resources to meet all of its long-term investments. The situation is therefore very worrying, because it means that the company is under-capitalized. In other words, it finances its investments with debt.
Working capital requirement
The working capital requirement indicates the amount that a company must possess in order to pay the current expenses during the cash flow swap. It is a key indicator of the company’s health that absolutely needs to be followed on regular bases.
Calculations: average inventory + accounts receivables – liabilities
The shorter your operating cycle, the less capital you need to finance it, which translates into less working capital.
To optimize the working capital, we must therefore use 3 main levers:
- Inventory management: By reducing inventory and improving its turnover, you reduce your operating cycle. To do this, you must optimize flows and shorten lead times as much as possible.
- Supplier payment terms: extend payment to your suppliers as much as possible to optimize your WCR.
- Customer payment times: conversely, you need to make sure you get paid by your customers as quickly as possible.
The KPIs to evaluate the profitability
The breakeven point
The break-even point is an essential KPI: it allows to calculate the needed level of revenue to reach to cover the expenses. Reaching the break-even point is a company’s objective, as it is the amount to surpass to start generating profit. The break-even point is generally calculated when the financial forecast is made.
In other words, it allows you to know when you will reach a sales volume sufficient to cover all your charges, fixed as well as variable. Until a break-even point is reached, the company does not have good financial security.
Furthermore, the breakeven point allows you to know the level of turnover below which you absolutely must avoid falling. In addition, this performance indicator is generally calculated during the preparation of the financial forecast.
Calculation: fixed costs / (revenue – variable costs)
It is a common indicator but there isn’t an “exact” definition: what is called gross margin generally implies the sales margin, which is the margin made by a company.
In other words, the gross margin represents the difference between the turnover and the cost price.
Its calculation is particularly useful to know if the activity of your company is profitable. It can be defined in different ways.
Calculation: sale price excluding VAT – purchase price excluding VAT
The gross margin is part of the Interim Management Balances (MIS), a set of performance indicators derived from operating income. It therefore enables an in-depth analysis of the level of profitability of the activity.
The net margin indicates the overall profitability of a business: the higher it is, the better the performance of your business. More precisely, it measures the profit generated by each euro of turnover, after subtracting operating costs, taxes, interest …
Thus, unlike the gross margin, the net margin takes into account all fixed and variable costs, but also income. This therefore gives a very precise vision of the financial health of the company.
A high net margin means that your business has good control over spending, making it highly profitable. It can also be put in contact with your competitors, to assess your profitability vis-à-vis theirs.
The net margin, the result of which is expressed as a percentage, can be calculated as follows:
Calculation: net profit/ sales revenue x100
KPIs to analyze the funds
Net Cash Position
Net cash (or availability on sight) corresponds to the sums available in the short term, as soon as the company needs it. These sums will make it possible to know the financial balance (or not) of the company: this is a good example of KPIs that must be followed regularly.
Indeed, cash is one of the cornerstones of your business. Without it, you cannot close the mismatches that are created between the inflow and outflow of money. A real threat to your solvency!
By keeping your cash flow under control, you can ensure you have cash on hand at all times. You are also able to meet all your financial commitments on time. Visibility and anticipation are at the heart of good business management: this is why it is an essential key performance indicator.
Calculation: working capital – working capital needs
Or: available funds – short-term liabilities
It is also in your best interest to use a cash flow forecast, especially in the form of a table or graph. This allows you to anticipate all your payment deadlines and estimate your ability to meet your financial commitments.
The net cash position corresponds to the short-term available amounts when the company needs it. These amounts allow to know the financial stability (or instability) of the company: it is imperative to follow this indicator.
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The clients’ average payment time
Finally, the average customer payment period, as its name suggests, means the number of days between the delivery of a service to a customer and the payment for that service. In other words, it is the time it takes for money to arrive in your bank account after issuing an invoice.
This is therefore a very important KPI for any business: this payment deadline has a major impact on cash flow. The faster your customers pay you, the faster you can pay your own invoices and make investments … Conversely, too long an average period can quickly put a company in difficulty, even a prosperous one! It must therefore be watched carefully.
Note that this indicator allows to know the working capital requirement, seen above.
Calculation: (receivables including tax / annual turnover including tax) x 360 days
Cédric FRADIN, former CFO in large groups and SMEs for more than 20 years and today President of DFCG Normandie, testifies to the benefits of BI for the Finance function: Performance management and rapid, reliable and relevant sharing of KPIs financial
With these few examples of calculations to know, you can get off to a good start in order to monitor your financial KPIs. Enough to ensure the good health of your business on a daily basis, with measurable and understandable indicators!
18 February 2019