Today’s finance teams have an instant access to data and analytics, helping them uncover insights and measure how financial activities affect the business.
Financial metrics are indispensable to improve business processes and operations. Making critical decisions without clear metrics often leads to relying on gut feelings, opinions, or untested hypotheses which is not the most strategic approach. Identifying the appropriate financial metrics can be difficult but is essential for making informed decisions.
The number of financial metrics available can seem like trying to select the “right” sweets at a pick and mix kiosk. The choices are there, but what is it that you’re really looking for?
CFOs and Finance Directors must therefore ask themselves:
- What financial metrics do I want to measure?
- What information am I looking to gain and report?
- How can I utilise information provided by these financial metrics to make informed and strategic decisions?
This guide is created to help you understand the different purposes and insights these numerous financial metrics can provide, empowering you to utilise financial data effectively for business success.
What is a metric in business terms?
Business metrics are quantifiable measures that a business employs to track and monitor its various initiatives, processes, and overall performance. These metrics are compared against benchmarks or specific objectives to assess progress and determine performance within a given timeframe.
Every aspect of the business has its own set of specific metrics. For example, employee retention or attrition rate are important business metrics concerning the HR department.
Why are financial metrics important in business?
Financial metrics are metrics used to assess and monitor a business's performance and efficiency from a financial standpoint. Profit margin, return on investment (ROI), cash flow, working capital and current ratio are some of the most important financial metrics. They are relevant not just for finance teams but also for various departments, senior management, external stakeholders and even investors. Their importance can be gauged from their role in achieving following tasks.
Understanding financial health
The assessment of financial metrics unveils a company's financial health and stability, offering tangible insights into its profitability, efficiency, liquidity, solvency, and holistic performance. Such revelations serve as essential tools for investors, analysts, and management in comprehending the company's status, prospects, and in facilitating informed decision-making.
Assessing and improving performance
Metrics allows you to assess your performance against industry standards and identify areas for improvement. For instance, if a business within a sector with a typical profit margin of 30% falls short at 15%, it signals underperformance, necessitating improvement efforts.
Strategic decision-making
Financial insights help assess the effectiveness of business operations and initiatives. For example, observing sales revenue helps gauge customer reception of a new product, while the number of new customers can serve as a clear indicator of a marketing campaign’s effectiveness. Such insights are crucial to refine strategies and optimise their outcome.
Financial metrics are also crucial for estimating expected performance. This forecast is essential for planning the company's future path and strategies. For example, forecasting cash flow and expenses helps with budgeting and financial management for the upcoming period.
Goal setting
Understanding past and present performance through metrics helps set achievable goals and guides future progression. Metrics also ensure that all departments and efforts align with the company's common goals.
Risk mitigation
Effective cash flow forecasting and tracking can uncover potential shortages and help you make necessary arrangements to prevent operational interruptions. This exemplifies how financial metrics are key to identifying and managing financial risks before they turn into major issues.
Communication tool
Financial metrics also are a powerful way of communicating business’ standing. For example, earnings before interest, taxes, depreciation, and amortisation (EBITDA) convey vital information about a company's financial health to customers, shareholders, employees, and the broader market.
How are KPIs used in finance?
Key Performance Indicators (KPIs) are measurable metrics used to track and assess performance in achieving key business objectives and strategic goals. Tailored to the strategic objectives of the business, they monitor progress and measure how effectively an organisation is achieving its targets.
There are two common uses for financial KPIs. The first one is financial reporting, where the business conveys information to shareholders. Examples of such KPIs include:
- Revenue growth rate
This KPI shows the increase in the company’s sales over a specific period. Increasing growth in revenue is a sign of a thriving business and market acceptance to shareholders.
- Earnings Per Share (EPS)
This KPI shows how much of the company's profit is allocated to each outstanding share of common stock. A growing EPS over time is viewed as lucrative by shareholders.
The second use is for internal auditing and process improvement. Some examples of these KPIs are:
- Cash Conversion Cycle (CCC)
CCC indicates the time taken to convert inventory and other resources into cash flow from sales. Monitoring the CCC provides valuable insights into operational efficiency, helping identify process inefficiencies and implement targeted improvements to optimise cash flow and overall performance.
- Operating Expense Ratio (OER)
OER shows what percentage of a company's revenue goes towards operating expenses. This KPI is useful for assessing how efficiently a company controls its operating costs. A lower OER indicates effective cost management, whereas a higher OER may highlight inefficiencies.
What is a growth metric?
Growth metrics are KPIs specifically targeted to highlight the underlying growth of a business over a specific period. They represent development across various areas of the business, including sales, marketing, operations and even employee engagement. Growth metrics can include anything from revenue, market share, average customer spend, customer retention rate to employee retention rate and Net Promoter Score (NPS).
These metrics, when compared year-over-year, can efficiently showcase the company's upward trajectory and progress.
Key metrics to track for CFOs and finance teams
There are several finance performance metrics a business can track, and the selection will vary depending on business type, and area of focus. However, some notable metrics are commonly applied across various industries. These include:
1. Operating cash flow
To ensure business survival, profitability, and growth, effective cash flow management is critical. A fundamental metric used for this purpose is operating cash flow, which is compared with total capital in use to determine if it is sufficient to support your investments.
2. Cash flow available for debt service
Cash flow available for debt service (CAFD) denotes the amount you can allocate comfortably towards new loans or financial commitments once all other costs are covered. It's imperative to keep this information easily accessible, especially given that investment opportunities can arise unexpectedly.
3. Growth and profit percentage
An essential metric to track is growth and profit percentage. Simply take your operating profit as a percentage of total revenue and add it to the annualised growth rate. The sum of growth and profit percentage should be greater than 40.
4. Profit and loss
Profit and loss KPI helps track your business revenue and expenses over a specific period. It reveals if your revenue is turning into a profit and is an excellent indicator of growth over time, aiding in budget maintenance and profitability.
5. Working capital
Cash that is immediately available is referred to as "working capital". It informs you of the condition of your business in terms of its available operating funds, by showing the extent to which your available assets can cover your short-term financial liabilities.
6. Current ratio
Calculated by dividing total assets by liabilities, it provides valuable insight into your business's solvency. It offers insight into how well your company is positioned to meet its financial obligations consistently on time and to maintain a level of credit rating that is required to grow and expand your business.
7. Debt to equity ratio
This critical KPI highlights your financial accountability by comparing your business's total liabilities to shareholders' equity (net worth). It indicates profitability, with a high ratio suggesting a reliance on debt for growth. This metric informs you and your shareholders about the extent of debt accrued in effort to become profitable.
8. Accounts payable turnover
This shows the rate at which your business pays off suppliers. This ratio is obtained by dividing the total costs of sales during a period (the costs incurred by the company while supplying its goods or services), by your average accounts payable for that period.
This is a very informative ratio when compared over multiple periods. A declining accounts payable turnover KPI may indicate that your company is taking longer to pay off suppliers. This requires action to maintain good vendor relationships and take advantage of time-sensitive discounts, possibly necessitating financial restructuring.
9. Accounts receivable turnover
This KPI measures how efficiently your business collects due payments from customers. It's calculated by dividing total sales for a period by the average accounts receivable during the same period.
This number can serve as an alert that corrections need to be made in managing receivables, to bring payment collections within appropriate timeframes.
10. Inventory turnover
Understanding how much of your average inventory is sold during a period is made easy with the inventory turnover KPI. It is calculated by dividing the sales within a specific timeframe by the average inventory, revealing your company's sales strength and production efficiency.
11. Return on equity
Return on equity (ROE) is a KPI that assesses your company's net income relative to each unit of shareholder equity (net worth). By comparing your company's net income to its overall wealth, your ROE indicates whether your net income is appropriate for your company's size.
This ratio both informs you of the amount of your organisation’s profitability and quantifies its general operational and financial management efficiency. An improving, or high ROE clearly indicates to your shareholders that their investments are being optimised to grow the business.
12. Quick ratio
Quick ratio measures a company’s wealth and financial flexibility. It is understood as a more conservative evaluation of a business's fiscal health than the current ratio because the calculation of the quick ratio excludes inventories from assets.
If you are a new adopter of KPIs, the quick ratio KPI is a good approach to getting a quick view of your business’s overall health.
13. Throughput time
Throughput time indicates the total time taken by a business owner to move a customer through the process from initiation to completion. Examining this one metric can help you identify ways to speed up the throughput and efficiently operating your business.
14. Monthly spend
This KPI determines your business's monthly expenditures. For effective growth, you need to be aware of your spending patterns, understand where the money is going, and seek ways to reduce costs by streamlining inefficient processes.
15. Lifetime value
Quantifying lifetime value can really help guide strategy. If you’re only tracking sales, you could be overlooking expenses that cut into net profitability. And if you’re only tracking expenses, you might not be setting up your company for growth.
Assessing lifetime value enables you to make informed spending decisions on customers who will remain valuable to your business over time.
What are the best tools for tracking financial metrics?
Manually tracking financial metrics is a cumbersome process, requiring meticulous record-keeping, involving documents like profit and loss statements, cash flow statements, and invoices. These records then need to be analysed and used for complex calculations to derive key financial metrics. This approach is time-intensive and prone to human errors in data entry and calculations. Fortunately, several technological solutions can greatly enhance and streamline this process.
Financials, our Cloud-based financial management software, exemplifies how technology can make tracking, analysis and reporting of financial data much easier. It combines the functionalities of multiple platforms into one single software, providing instant access to financial data in one place. It can generate reports across all financial areas, including general ledger, accounts payable and receivable, fixed assets, sales invoicing and orders, and project tracking. Reporting is done directly within the solution, and being Cloud-based, the information is automatically updated in real-time, providing you the most current data.
The software includes 1,000 built-in sample reports for quick reporting. If these do not suit your purpose, it allows for the creation of custom reports. Additionally, all these reports are downloadable, and Financials can work alongside tools like Tableau or Power BI, providing flexibility to easily export it and combine it with your broader organisational data, creating a unified view that fuels impactful insights and data-driven business decisions.
Why should financial metrics matter to you?
In finance, planning, analysis, and reporting metrics have always been essential. Small and medium-sized businesses, just like large corporations, should prioritise these practices from the start. Leveraging financial planning and analysis early and investing in the right technology can yield substantial benefits.
Leading companies globally rely on metrics to achieve success, with their ability to utilise collected data playing a pivotal role. In an increasingly competitive global marketplace, understanding key performance metrics such as product profitability, cash flow, customer preferences, and staff productivity provides a vital competitive edge. Businesses that know which metrics to use and what they will measure can make more confident long- and short-term decisions by better managing uncertainty and minimising risk.
By capturing and monitoring data, you can make sophisticated, well-informed decisions, giving you the opportunity to surpass and outmanoeuvre competitors who fail in this area. This data can be used by management to navigate the business through both prosperous and uncertain periods.
With our Cloud-based accounting software, Financials, get instant access to the data and metrics you want to measure. With its real-time automated reporting, confidently make strategic decisions to stay on top of your game.