What KPIs should finance be tracking?
Key Performance Indicators are critical measures of the performance of your business and should be tracked to provide an objective indication of progress and help inform better decision-making.
KPIs can track efficiency, effectiveness, quality, time, governance, compliance, economics, or resource utilisation.
Many different KPIs can be tracked, depending on your industry, strategic goals, operational focus, projects or business functions.
The following sections cover the most important KPIs your Finance team should track, explain how to calculate them, and why they are critical to your business's success.
1. Operating Cash Flow
The Operating Cash Flow (OCF), also referred to as cash flow from operating activities, is the amount of cash generated by a company's regular business operations.
This is an important benchmark to determine the financial success of your company's core business activities and indicates whether your company can generate sufficient positive cash flow to maintain and grow its operations. It may need to borrow from external sources to finance any expansion if there is insufficient cash flow.
Financial Analysts often look at the Operating Cash Flow because it is a critical figure used to assess the financial stability of a company's operations.
2. Working Capital
Working capital, also known as net working capital, is the difference between a company’s current assets and current liabilities. It is a measure of a company’s liquidity and short-term financial health.
Working Capital = Current Assets - Current Liabilities
Current assets include cash, accounts receivable, inventory, and other assets that are expected to be liquidated or turned into cash in less than one year.
Current liabilities include accounts payable, wages, taxes payable, and the current portion of long-term debt due within one year.
Working capital is an essential KPI because it measures your company’s operational efficiency and short-term financial health. A company with significant working capital will have the potential to invest in and grow the company. If a company’s current assets are less than its current liabilities, it may have difficulty paying creditors or investing in growth.
3. Current Ratio
The current ratio is a liquidity ratio* that measures a company’s ability to pay short-term debts or those due within one year. This is an important KPI that investors and analysts use to determine if a company can maximise the current assets on its balance sheet to satisfy its existing debt and other payables.
Current Ratio = Current Assets / Current Liabilities
The current ratio is calculated by dividing the total value of current assets by the total value of current liabilities.
Current assets are those that can be converted into cash within one year, while current liabilities are obligations expected to be paid within one year.
Examples of current assets include cash, inventory, and accounts receivable.
Examples of current liabilities include accounts payable, wages payable, and the current portion of any scheduled interest or payments.
*Liquidity ratios are an important class of financial metrics used to determine a debtor's ability to pay off current debts without raising external capital.
4. Debt-to-Equity Ratio
The Debt-to-Equity ratio is calculated by analysing the business's total liabilities compared to your shareholders' equity (net worth). This critical KPI helps you focus on your financial accountability.
The KPI indicates how well your business is funding its growth and how well you are utilising your shareholders' investments. The number indicates how profitable the business is, and it tells you and your shareholders how much debt the business has accrued in an effort to become profitable.
A high debt-to-equity ratio reveals a practice of paying for growth by accumulating debt, which may not be sustainable in the future.
5. Burn rate
Your company burn rate shows the speed at which cash is being spent.
Whether assessed monthly, daily or yearly, monitoring burn rate regularly can be extremely useful as it reveals whether your business can maintain its spending rate over time. This is a key strategic performance priority.
However, burn rate is an example of a KPI which needs cross-departmental collaboration to show the true picture. For example, Finance may see a printed-out list of outgoings from Marketing, but without a system that allows the two teams to collaborate both qualitatively and quantitatively, Finance may not know that spending is particularly high because of a strategic marketing priority that month. Collaboration between teams is necessary for an accurate, contextualised burn rate calculation.
6. Inventory turnover
There are several different ways to work out your inventory turnover – which is how quickly you can replenish product stock or service capacity.
Keeping track of inventory turnover is particularly effective from a performance point of view because it can help motivate people to improve performance.
Once you have worked it out, you can communicate the results to your logistics group or similar teams to give them a stock turnover target to work towards.
7. Payment error rate
The payment error rate reflects the proportion of your company’s failed payments to those you owe. Payment error rates often occur due to problems with signoffs, manual keying errors and other issues.
A high payment error rate can be a wake-up call for Finance and the senior leadership team. It indicates that payment systems may need to be updated – supporting the business case for a Finance software package that can automate these functions and improve collaborative workflows.
8. Net Profit Margin
The net profit margin is one of the most important KPIs to track since it is a significant indicator of a company’s financial health.
It measures how much net income is generated as a percentage of revenues received and helps investors determine if a company is generating enough profit from its sales. It also enables investors to determine whether operating and overhead costs are sufficiently maintained.
The net profit margin shows how much of each pound of revenue generated by a company is profit. The larger the net profit margin, the more every pound is kept in profit.
9. Gross Profit Margin
Gross profit margin and net profit margin are two KPIs used to assess a company's financial stability and overall health.
The gross profit margin is the percentage of revenue that is left after accounting for the cost of goods sold.
This is an important KPI because it indicates whether a business can pay its operating expenses and has enough funds left over for growth.
Gross profit margin is calculated by taking total revenue minus the cost of goods sold and dividing the difference by total revenue. The gross margin result is multiplied by 100 to show the figure as a percentage.
Gross Profit Margin = (Total Revenue – Cost of Goods Sold) / Total Revenue * 100
The gross profit margin is usually a stable figure in a business unless there has been a major change affecting the business, such as a change in costs or pricing.
10. Current Accounts Receivable
Current Accounts Receivable measures the amount of money due to a business for goods or services delivered to its customers but not yet paid for. The Current Accounts Receivable KPI represents money owed to a company in the short term.
Accounts receivable is an important and fundamental KPI and measures a company's liquidity or the ability to cover short-term obligations without additional cash flows.
A high figure may mean that a business is struggling to deal with long-term debtors and may lose money if the debtors cannot pay their bills in the long term.
Tracking current accounts receivable along with current accounts payable can help the finance team plan cash flow and plan additional team expansion.
11. Current Accounts Payable
Current Accounts Payable are the opposite of current accounts receivable and represent the amount of money owed by a company to its suppliers or other third parties.
Current accounts payable represent short-term debt that must be paid off within a specific period of time. It may be the company policy to pay outstanding bills as late as possible to improve cash flow.
Current accounts payable is an important KPI to track alongside current accounts receivable. If current accounts payable increase over a certain amount of time, it may mean that the company is buying more goods or services on credit rather than paying cash.
If it decreases, the company may be paying off its debts faster than it is purchasing new items on credit.
Therefore, current accounts payable management is critical in managing a business's cash flow.
Why are finance KPIs so important?
Finance KPIs are important because they are measurable values that indicate how well a company is performing. They help the business to align with strategic goals, such as growth, revenue, profit, performance and sales.
Implementing and measuring financial KPIs enables the finance team to track the performance of the business and to report on year-on-year performance or alter direction if necessary to meet the business targets.
Additional KPIs to monitor
In this article, we have covered the top 11 finance KPIs to track. However, there are many more that your finance team can monitor, depending on your industry, strategic goals, operational focus, projects or business functions.
Here are a few suggestions of other business KPIs to track:
- Customer Satisfaction – the results from customer satisfaction surveys and other customer feedback scores.
- Recurring Revenue – areas of recurring income and expense, such as service contract fees, subscription fees, and product support and maintenance fees.
- Cost of the Finance Function – the total cost of the finance function in relation to the total revenue, including staffing costs, system costs, overheads, and any other expenses.
- Marketing KPIs – such as Customer Acquisition Costs, Lifetime Value, Profitability, Ad Spend, and other marketing costs.
- Finance Error Report - finance reports that require further investigation due to errors and therefore incur additional costs.
How financial management software can help you track finance KPIs
Financial reporting software can help you track your finance KPIs by providing real-time financial reports within seconds rather than days or even weeks.
You can quickly run reports on your financial health or business performance and easily monitor the business with live dashboards, rather than having to manually collate and format data, which can take many hours and add to the cost of running your finance team.