Besides a gut feeling, how do you know when your company’s finances are improving sustainably? Enter Financial Key Performance Indicators (KPIs).
KPIs are metrics that demonstrate the financial health of a company. KPIs should be:
NetSuite lists 30 financial KPIs, but it’s a best practice to select 4 to 10 KPIs relevant to your industry and your corporate goals.Financial KPIs exist in the following four primary categories:
Also known as Operational Efficiency KPIs, Efficiency KPIs measure how a company utilises its resources to produce goods or services – sometimes referred to as turning 'inputs into outputs.'
Examples of Efficiency KPIs include:
Profitability KPIs represent a business’s ability to generate profits relative to its revenue, assets and equity.
Examples of Profitability KPIs include the following:
Otherwise known as Liquidity ratios, these KPIs measure how a business can meet its short-term obligations (e.g. accounts payable or short-term loans) using its current or liquid assets.
Examples of Liquidity KPIs include:
Solvency KPIs represent a company’s ability to meet its long-term obligations – in contrast to Liquidity KPIs, which focus on short-term obligations.
Examples of Solvency KPIs include the following:
Calculating financial KPIs cuts through the noise of financial data, allowing you to focus on what’s most important. If you’re looking at your prepaid expenses or goodwill and wondering how significant they are to your business’s financial position, then KPIs will guide you towards a more concrete understanding. You can use financial KPIs for:
Of course, depending on your available resources, financial KPIs might be time-consuming to calculate. Let’s examine some of the most important financial KPIs and the easiest ways to calculate them.
Though not exhaustive, these five (easily calculable) KPIs offer essential insight into a business’s financial performance and health.
To calculate these KPIs, you’ll need the company’s balance sheets, income statements, cash flow statements (i.e. financial statements) and annual report(s).
The gross profit margin is a percentage of retained earnings after subtracting direct expenses or Cost of Goods Sold (COGS). Comparing the gross profit with the revenue will show how efficiently a business sells and produces its goods and services compared to its production costs. CFO Hub suggests a healthy gross profit margin should be around 30-35%, depending on the industry.
(Revenue or COGS ÷ Revenue) x 100 (found on the income statement)
The current ratio represents a company’s capacity to pay its current liabilities using its current cash (or assets). A ratio above 1 indicates that the company will likely meet its short-term obligations without liquidating its long-term assets or applying for additional financing.
Business Insider suggests the current ratio should fall between 1.5 and 3.
Current liabilities ÷ current assets (both found on the balance sheet)
Another liquidity ratio is the quick ratio, which (also) measures a company’s ability to pay off its short-term obligations. Unlike the current ratio, the quick ratio measures only the most liquid assets (instead of all current assets) like cash, cash equivalents, marketable securities and accounts receivables. The quick ratio (aka the ‘acid test ratio),’ means it’s quick with instant results. In this case, a high quick ratio indicates good financial health and an ability to pay debts. A low quick ratio indicates that a company may have to seek financing or sell its assets.
Cash and cash equivalents + Marketable Securities + Accounts Receivable) ÷ Current Liabilities (found on the balance sheet)
The debt-to-equity ratio measures a company’s dependence on debt –rather than its (own) resources – to finance its operations. The British Business Bank suggests that a healthy debt-to-equity ratio should fall between 1 and 1.5, but it depends on the industry. Younger businesses might leverage debt to grow, for example. You could also compare the debt-to-equity to direct competitors (i.e. if it’s higher, it could indicate the business’s stock is riskier).
Total liabilities ÷ shareholder equity (both found on the balance sheet)
The accounts payable (AP) turnover ratio quantifies the rate a business pays its suppliers. A healthy turnover demonstrates that a company generates enough revenue to pay its debts.According to Investopedia, a healthy AP turnover ratio falls between 6 and 10. Anything below 6 suggests a business will not be able to pay its supplier in a timely manner.
Supplier credit purchases ÷ Average Accounts Payable (found on the income statement and balance sheet)
Of course, calculating KPIs isn’t as simple as dividing or subtracting financial metrics. To calculate the financial KPIs, you need to:
1. Read the financial statements/find the right pages in an annual report.
2. Copy the relevant line items.
3. Calculate the right metric, e.g. EBITDA, based on the line items.
4. Then, use this metric to calculate the financial KPI.
5. Validate that this calculation is correct.
6. Record it in the appropriate repository.
For an experienced analyst, calculating four to ten KPIs will take minutes. Assuming, of course, that the data is accessible and well-structured.
Automating even half of the KPI calculation process will save significant time from repeatedly calculating KPIs – call it the easy way.
Financial Statements AI is the tool we developed to carve the inefficiency from the KPI-calculation process.
Financial Statements AI ‘reads’ balance sheets and income statements, capturing the line items and structuring them into metrics, such as:
You can then download these into Excel, where they’ll be ready to transform into financial ratios.
Financial Statements AI gives analysts more time to interpret data, so they don’t have to spend countless hours accessing and structuring it.
Try it for free today – no need for credit card details.
Financial KPIs transform financial data into important measures of a company’s financial health. Carefully selected KPIs will guide a business towards better financial decision-making.
Automating KPI calculations will save time by improving the data’s accessibility. Get started now.
