As a small business owner, you wear many hats.
You’re the strategic visionary, salesperson, chief marketer, HR manager, supervisor and maybe even the front-line customer service rep. Not to mention you stay ahead of the competition, motivating your team and keeping up with industry trends.
That’s a lot to juggle and we haven’t even talked about the financial side of things. To change the world, you’ve got to keep the lights on, right?
Manage your company’s money easily by understanding and tracking the following 14 financial key performance indicators (KPIs):
- Operating Cash Flow
- Sales Growth
- Earnings Before Interest and Taxes (EBIT)
- Transaction Error Rate
- Current Ratio
- Quick Ratio (Acid Test)
- Burn Rate
- Gross Profit Margin
- Net Profit Margin
- Working Capital
- Return on Equity
- Debt to Equity Ratio
- Current Accounts Receivable
- Current Accounts Payable
Let’s dive into what each of these terms mean and why they’re all crucial to your business.
Why These 14 Financial KPIs Matter
We get it. You didn’t start your business to stare at spreadsheets and punch numbers into a calculator. When someone asks what you do, your eyes light up talking about the handmade products you create, or the life-changing services you offer. They certainly don’t light up at the words, “Transaction error rate.”
But here’s the thing: You need to know and get excited about these numbers, too. Maybe not the level of excitement you have for your company’s purpose, but pretty close.
Why? Three little words: investment and growth.
Let’s say you want to expand your factory to produce more products and enter new markets. Or, lease a larger office space and hire more staff, allowing you to take on more clients.
Awesome, right? Until it comes time to get the money to make it happen.
Whether you seek a conventional business loan from a bank or go the investor route, the person on the other side of the desk (or hors d’oeuvre tray) isn’t interested in hearing you go on and on about how you import all your materials from Denmark because only the best quality will do for your hand-knotted rugs.
The person is interested in the cold, hard numbers.
- “Is this person in a solid financial position to make this expansion successful?”
- “What is the risk level I’m taking by investing in this business?”
- “How does this business currently handle accounts? Do they have a proven track record of balanced budgets and paying vendors on time?”
These are all things a bank or potential investor needs to know.
Without solid, irrefutable proof of those answers, it will be difficult to nearly impossible to secure capital investment to make your business dreams a reality.
Think this article isn’t for you because you’re not planning on taking out a loan? Newsflash: The health of these financial KPIs directly equals the health of your business.
You can’t plan for your future growth — investment-seeking or not — without first knowing these numbers.
1. Operating Cash Flow
There’s a reason this one is first on your cash-flow statements: it’s a way to tell if your business is earning enough to keep operating. Your operating cash flow is how much money your business earns through regular business activities.
The simplest way to track this is by adding up all your inflows (sales, invoices) and subtracting outflows (purchases, expenses, etc.). The remaining figure is your operating cash flow.
We’ll get into more specific cash-flow measurements later.
2. Sales Growth
This one is what it sounds like: the percentage of revenue growth over a set period of time. For example, how much your revenue grew this year versus last year.
Would anyone want to invest in a company that was losing money year over year? Not likely.
Knowing this number is also what allows you to set forecasts and goals for growth.
3. Earnings Before Interest and Taxes (EBIT)
This is a basic calculation of your income minus expenses, before you count any interest and taxes. It’s a basic gauge of profitability by telling you if you’re consistently spending more than you’re making.
4. Transaction Error Rate
A transaction error can be anything from a form being filled out incorrectly to money deposited in the wrong account or expenses not being properly tracked or deducted for income tax purposes. Transactions are funneled into 3 main categories: payable, billing and cash receipts.
Making errors is human nature, but too many can quickly erode your overall efficiency and have a serious, harmful impact on profitability.
Each of the 3 transaction categories should have their error rate tracked individually to give you an idea of where systems are breaking down, if there is an issue.
In this example from Accounting Tools, you can see the cash transaction error rate is 0.9% but the billing error rate is 12.6%. From this, we can surmise that something is happening in the billing software to cause such a high level of mistakes — and it’s costing you money.
5. Current Ratio
This is a measure of how solid your business is on a short-term basis, usually defined as 1 year. The current ratio shows whether you’re able to pay your upcoming obligations based on current revenue and the assets you own.
It isn’t a perfect measurement but it gives you a quick glance at the stability of your business.
The formula to calculate this is:
Ratios are judged based on industry averages, so if you’re in line with or slightly better off than most in your industry, banks are happy with that.
6. Quick Ratio (Acid Test)
Similar to the above, a quick ratio (also known as an acid test) measures your current assets against short-term liabilities. However, it only counts assets that would be quick to sell such as cash, cash equivalents such as investment accounts and occasionally accounts receivable.
This ratio ignores assets that would be difficult or take a long time to sell, such as real estate, inventory, equipment and other property.
7. Burn Rate
Not as fun as it sounds, this is how quickly your company is depleting your revenue — or “burning through money.”
Many startups don’t turn a net profit for months or even a year as everything earned goes back into the business to improve their product or acquire new customers.
In cases like this where profitability isn’t expected right away, investors look at how quickly a company is burning through cash to get an idea of what its value is and how likely it is to turn a profit in the future, if it’s able to increase revenues through marketing efforts. It tells them how far their investment will take the company in time.
Burn rate can be tracked with a monthly cash-flow statement, such as this example below from Corporate Finance Institute. You take your revenue and subtract expenses. If your remaining profit is in the negative, that’s the burn amount.
If you have $5,000 in cash assets to survive off of before you need to turn a profit (or get an investor), then your burn rate is that figure divided by the negative profit amount. In this case, it would be $5,000 / $500 = 10, so 10 months until you’ve burned through all your assets.
8. Gross Profit Margin
Gross profit margin is your overall revenue (sales) minus your cost of goods (COGS) sold.
Cost of goods sold will include different things depending on the business, but common things to factor in are your raw materials for making your product or delivering your service, plus factors such as overhead, electricity, equipment leases, and of course, labor.
Generally, things like rent or mortgage costs and sales or marketing expenses aren’t included in a COGS calculation.
9. Net Profit Margin
Net profit margin is where things get more specific, moving from a general show of profitability to a precise calculation of a company’s true profit.
This takes everything in the gross profit margin calculation above and adds in all other expenses, such as rent, sales, marketing and other business expenses.
This number is essentially how much you get to keep from every dollar your company earns and it’s an important measure of profitability and efficiency.
Before you can know this, you need to know your net profits (Revenue – COGS) and net sales (Revenue – Returns and Transaction Fees).
10. Working Capital
Your working capital is similar to your quick ratio, as described above. However, it’s a short-term measure, like a snapshot of your business on any given week or month.
Working capital features all your current assets (cash, accounts receivable, inventory, etc.), minus your current liabilities (accounts payable, operating expenses).
If you are regularly earning more than you spend, it shows you should potentially think about growth opportunities or ways to invest that capital.
If you aren’t, it’s time to improve your efficiency, profit margin or make some other tough calls to bring your books in line.
11. Return on Equity
This one is key for attracting investors and keeping your current ones happy.
Return on equity (ROE) is your company’s net income divided by shareholder equity (or, in the case of a company without shareholders, the owner’s equity).
This number is a percent and reflects the financial growth for shareholders over the previous year.
This shows that your company is able to take in investments and actually turn a profit with them, and precisely how much profit was generated by those investments.
12. Debt to Equity Ratio
Similar to the above, debt to equity is your company’s total liabilities divided by total shareholder equity.
This ratio is important for evaluating the risk level of your business, especially when it comes to seeking investment from others or trying to qualify for a business loan. If you’re overleveraged, most lenders will take a hard pass.
In the examples below from Investopedia, we can see the risk difference between Company 1 and Company 2. Company 1 has 5x as much debt as they do revenue, which is a high risk for loan default. However, Company 2 earns twice as much as they owe: a safe bet for most lenders.
13. Current Accounts Receivable
This is a simple one you should be able to access at all times. Your accounting software should be able to spit this number out in 2 seconds. Your receivables are the amount of money currently owed to you by all your customers.
This can be made up of invoices, pending sales charges, or invoices that will become due in the time period you’re looking at. Most people tally this number on a monthly basis, but it can be any period of time from a few days to a year.
14. Current Accounts Payable
This is all the money you owe to vendors, contractors, or for other business expenses. It doesn’t include your payroll.
Sometimes, you may choose to pay bills later than you normally would to accrue capital to use for other things. Other times, you may pay your bills instantly. Whatever your cash flow goals are, you should always pay bills before their due date.
Grow Your Business With the Power of Numbers
You can’t grow what you don’t know.
Catchy rhymes aside, you really can’t grow your business or make any future plans without knowing these 14 financial KPIs. Without them, you’re taking a running stab in the dark at profitability and may never know if you actually reach it.
Knowing these financial KPIs can be the difference between success or failure in any industry.
It can also mean securing a life-changing business loan or investment to expand beyond your wildest dreams or watching the opportunity of a lifetime slip by, unable to act because no one will lend to you.
Working in your business is probably where you’re the happiest, but don’t forget to work on your business, too. The numbers don’t lie and if you let them, they can even be your biggest asset.