In the current volatile business setting, the management needs to monitor and evaluate the organisational financial performance in order to thrive in the business environment. Financial KPIs are one of the critical sets of quantitative measures that help business organisations evaluate their financial performance and make effective decisions. The Key Performance Indicators (KPIs) Training program offered by the British Academy for Training and Development helps to understand how to set, measure, and analyse key performance indicators.
This article explores what financial KPIs are? Why are they significant? and 10 important KPIs for measuring success.
Financial KPIs are quantifiable metrics that provide essential information about a company’s financial performance and suggest possible improvement directions.
These indicators assist in measuring the effectiveness and financial viability of any organisation. They are useful in planning and development, to ensure that the business becomes more financially sound. Measuring KPI in finance helps an organisation compare its performance with a set of standards which in turn helps in analysing areas that need improvement, either by expanding or by managing risks.
Most financial KPIs are divided into five categories according to the type of data they measure:
Profitability KPIs
Profitability key performance indicators demonstrate how well a company is capable of making profits in relation to revenue, assets or equity. Some of the most commonly used are Net Profit Margin, Gross Profit Margin and Return on Equity (ROE).
Liquidity KPIs
Liquidity KPIs deal with a company’s capability of reaching compliance with short-term obligations, which means the potential for covering short-term liabilities with the help of available assets. Some of the examples are the Current Ratio and Quick Ratio.
Efficiency KPIs
Efficiency KPIs measure the overall profitability or the level of resource utilisation in generating revenues which informs operational efficiency. Some examples are Inventory Turnover and Accounts Receivable Turnover.
Leverage KPIs
Leverage KPIs evaluate the financial leverage exhibiting the attitudes of a company to risks and debts. Some examples are Debt-to-Equity Ratio and Interest Coverage Ratio.
Cash Flow KPIs
Cash Flow KPIs give an idea about the cash being generated and used in a company’s operation, investments and financing activities like Operating cash flow and free cash flow.
The importance of financial KPIs in business cannot be overstated. They give a clean snapshot of a company’s financial health and future prospects, which may be informative to the investors, shareholders, and management. Here are some reasons why financial KPIs are indispensable:
Decision Making: Financial KPIs are used to improve key managerial decisions such as resources control, controlling cost, and revenue generation.
Performance Tracking: They enable organisations to compare their performance at different time intervals in order to know their level of strength or weakness.
Goal Setting: KPIs help set achievable integrated financial targets and ensure the business keeps track of resource utilisation towards accomplishment of these goals.
Risk Management: When financial performance indicators are monitored, a firm gets ahead of time a glimpse of its financial vulnerability and should take necessary precautions to mitigate them.
Investor Confidence: Accurate and transparent financial measures enhance investors’ trust and results in a better company image and consequently increased investment.
Businesses need to know and analyse Key Financial Performance Indicators to monitor the financial health of an organisation. Here are 10 essential KPIs that businesses commonly used to assess their performance:
Gross Profit Margin shows the portion of the total revenue a company generates after removing the cost of goods sold within a given period. It reflects a company’s measure of how it has been able to manage the cost of production in relation to its sales. Cost control and the level of profitability are evidenced by a higher margin.
Net profit margin shows the amount of percentage of net income that remains after adding up all the expenses, taxes and cost of a business. This KPI is one of the key measures of the total profitability of a company and its stability on the financial market. An increased figure indicates a capability in cost management and good business profitability, thereby a higher net profit margin.
The current ratio is also known as the liquidity ratio that gives insight into the efficiency of a company to meet short-term obligations using its short-term assets. It reveals that the company is financially healthy in the short term and possesses an adequate ability to meet its present obligations in case of a higher value ratio.
The Debt-to-Equity Ratio is an indication of a firm’s financial leverage which compares total liability with equity. This ratio indicates the proportion of the company that is funded through debts, and hence gives information about financial risk and solidity.
Return on Equity (ROE) shows the extent to which the management harnesses the shareholders’ equity to make profits. Therefore, the higher the ROE the better is the utilisation of investment, and the better the financial position and efficiency of the management.
EBIT indicates the basic earnings level excluding interest and taxes, revealing the income from operating business activity. It reveals information about business operational productivity and profitability of earnings from core activities.
The Quick Ratio, also known as acid-test ratio, estimates how much of the short-term liabilities are likely to be covered with the most liquid assets. Unlike the current ratio, it excludes inventory, hence it is more concerned with immediate liquidity and a company’s ability to meet urgent financial demands.
Operating Cash Flow provides an insight into cash income from a business entity’s major activities. This KPI determines if the business generates adequate cash in a given financial period without having to go for more external financings, implying financial sustainability.
Revenue Growth Rate measures the rate of growth in the company’s revenues over a given period providing insights into company’s sales growth and how well it is doing in the market. Higher growth rate implies effective sales management and maintaining a competitive edge in the marketplace.
Interest coverage ratio assesses a company’s capability to pay interest on its debt by comparing EBIT to interest costs. This ratio measures a company’s capacity to meet its debt obligation respectively and financial solvency with higher figures representing higher debt management capacity.
These important value-based financial performance indicators give an overall picture of the profitability, liquidity and operational efficiency of a company and can be very useful for strategic decision-making.
In summary,
Measuring and analysing essential financial performance indicators is vital to any organisation that wants to bring longevity to its operations. Such measures provide valuable information on performance and measures to enhance the organisations’ financial bottom line.
1. What are the top 3 financial metrics?
The top three financial ratios of consideration are: Net Profit Margin, Gross Profit Margin and Return on Equity. These metrics give a general outlook of profitability and productivity in the creation of returns.
2. What are examples of KPIs?
Financial KPIs examples are Accounts Receivable Turnover, showing the effectiveness of collecting money from customers, and Inventory Turnover, that measures the frequency of conversion of inventory into sales and replacing the sold inventory, which reflects customer and inventory demand.