Maybe you’re working on closing your 2020 financials at this very moment, gathering all relevant information with your accounting team. If so, it’s the perfect time to take a look at a few KPIs that can naturally be drawn from your yearly financial statements.
Still, you don’t have to wait for tax time to benefit from these KPIs. We’ll also show you what metrics should be available at all times to give your managers the ability to adjust strategies and improve profitability ongoingly.
In this article, we’ll review the key indicators that you want to include in your financial dashboards and describe how to apply them to your business. They can provide actionable information about your teams’ performance and your cash flow.
You’ll be able to assess performance and profitability quickly and make better, smarter decisions for your business as a result.
Tracking Sales and Expenses
When you compare on a regular basis your actual sales performance with what you have forecasted, it’s easier to adapt and modify your strategies over time as needed and control costs. You can find gaps in your net sales (i.e. turnover) and your costs by subtracting your actual cost of operations from a target expectation for a given period. Doing so lets you stay on top of your budget and analyze the evolution of your sales activity. Comparing forecasted and actual sales on a monthly basis also allows you to review and readjust your annual business goals.
When you review KPIs such as Total Actual Sales, Total Budgeted Sales, and Corresponding Gaps, you have to ask yourself where the budgetary differences between your estimated budget and your actual turnover came from and whether they are favorable to you or not. Good questions to ask might include:
- Were your estimated budget goals too high?
- Were your sales worse than expected?
- Are you facing new competitors in your industry?
- Where is the difficulty?
Take time to analyze the variations in your expenses over time, too, to understand where they come from. This will allow you to stay in control of your activity in several ways.
First, you’ll be more able to pinpoint the source of the budget gap. For example, if you have unexpected expenses, you might find out if it was related to an isolated, one-off circumstance or a circumstance that might recur in the future.
The analysis also helps you stay on top of your activity because you can more readily implement corrective actions as well as make necessary adjustments to your budget.
Monitor Your Profitability
Like any business executive, treasurer, or administrative and financial director, you want your business to be profitable. Two KPIs can help you quickly see if you are:
- The Neutral Point. This metric allows you to determine the time required for your business to reach its breakeven point. By monitoring this indicator, you can respond more quickly and change your strategy as necessary if the sales results are not what you expected. This threshold can be determined by the income from services or products sold that is needed to balance the business’ expenses. The shorter the time, the faster your business will be paid off.
- Profit vs. Turnover. This is one of the best indicators of performance, whether you are a small business or a large international corporation. The ratio of your operating profit to turnover is a helpful indicator of the performance of your core activity. It lets you know the commercial efficiency of your business. You should not take into account exceptional results or financial results to analyze the performance linked to your activity. This metric helps you judge and compare your business’ performance with the average for your industry. That will help you determine if you are on the right track or if you need to change your strategy to develop your sales further.
Working Capital And Its Relevance to Cash Flow
Your business’ cash flow depends both on your financial resources and on the lags between receipts and disbursements.
With a positive cash flow, your resources are sufficient to meet your financial needs; when you have a negative cash flow, you need to quickly find additional sources of funding. Thus, having ready access to your cash flow totals is important.
To calculate your business cash flow, you need two metrics:
- Need for Working Capital. This tells you the financing needs of your business.
- Working Capital Fund. This metric reflects the financial resources you’ve acquired over the long term, including equity, loans, depreciation, and provisions.
Any business needs to have sufficient financial resources to meet its needs and pay its expenses, including fixed charges, supplier invoices, taxes, and duties, etc.
If you want to make your business sustainable, focus on a global vision of your cash flow over the medium term in order to be able to anticipate potential risks, quickly target cash flow gaps, and, as a result, react accordingly.
Reduce Your Trade Receivables
In addition to regularly monitoring your profitability and your cash flow, trade receivables are an element that you absolutely must take into account and monitor for good cash management. If you don’t, they can cause you significant cash flow gaps.
By minimizing your customers’ receivables, you minimize your risk of negative cash flow. However, remember to adapt to the financial situations of your customers.
Some will be ready to pay immediately, others can pay in installments, and still, others will delay paying until you are forced to send them a collection letter.
Understanding your customers will certainly allow you to know how financially reliable they are, but more importantly, it allows you to adjust your investments in order to keep your cash flow positive.
Of course, don’t forget to nurture your customer relationships as best you can. Understanding your customers and adjusting to their payment needs will help you retain them.
Optimize Your Supplier Debts
Optimize your supplier debts
Depending on your cash flow forecast and the actual level of your liquidity, two solutions are available to you regarding your trade payables: you can either pay invoices as quickly as possible or negotiate your payment terms.
In any case, remember to establish agreements signed by your suppliers concerning the authorized deadlines and the discounts granted, if there are any.
If you have sufficient financial resources, paying your bills quickly can be a good way for you to save money with discounts from your suppliers. Today, many companies are giving discounts for early payment, so take advantage! Doing so will also allow you to obtain more cash to finance your Working Capital Fund.
Conversely, if your business is having difficulties, don’t hesitate to negotiate your payment terms with your suppliers. Doing so will make it easier for you to wait for your customers to pay you before you pay the bill.
Derived Metrics From Your Financial Statement
Key financial statement metrics include earnings before interest and tax (EBIT), net income, earnings per share, margins, efficiency ratios, liquidity ratios, leverage ratios, and rates of return.
We’ll focus on the favorite of financial professionals, the one that is used to assess the financial health of a business: the gross operating profit. It’s calculated by subtracting the operating expenses from its receivable income.
Gross Operating Profit = Receivable Income – Operating Expenses
Improving your EBIT helps to guarantee the future of your company. It makes it possible to invest in growth without degrading profitability.
But with what levers?
First, work on margins
Break them down by customer, by product, by geographic area, and so forth. To do that, you will need to develop cost accounting in order to identify sources of loss so you can eliminate them, as well as promising sectors, so you can shore them up.
Then review your purchasing policy, beginning with rethinking your relationships with your suppliers. Companies that use subcontractors in their manufacturing process should question their mastery of the value chain and the vulnerability that subcontracting can cause. Consider know-how and technical dependence, logistics problems, quality, and their more or less difficult-to-negotiate prices.
If you choose to subcontract, be sure to put in place a partnership strategy and define productivity plans. By making a lasting commitment with your service providers, you can ask them to improve their productivity in return.
In this way, it is no longer a question of putting pressure on pricing by demanding immediate discounts or by setting them relative to the volume purchased. It becomes about breaking down the cost structure of the products or services purchased and helping suppliers find levers of productivity.
Next, analyze your overhead purchases
This involves doing a thorough needs study, which requires looking into the smallest details to identify potential savings.
In IT, for example, it is necessary to analyze the distribution of costs between IT equipment, software fees, external service providers, and salaries. Obviously, this involves the complete and periodic renegotiation of general expense contracts—electricity, vehicle fleet, insurance, etc.—which can result in significant savings.
Then, review all business processes to make them as efficient as possible. That includes scrutinizing the overhead of support functions for ways to simplify the organization and increase the added value of each employee by eliminating unnecessary tasks.
Digitization makes it possible to improve business processes and increase efficiency. This is especially true in accounting, where very time-consuming entries can be deleted thanks to digitization and the greater involvement of operational teams.
In conclusion, there are relevant financial metrics that one needs to monitor on a very regular basis. Your list of critical indicators will depend upon your business; beyond the ones listed above, metrics related to your specific industry or business model like SaaS businesses might be valuable additions.
You can use our dashboard templates and our data management platform to track your financial KPIs in real-time.