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Which KPI is most important?

The 5 Most Important Financial KPIs That Drive Business Strategy Sales Growth Rate. Performance Indicators. Revenue Concentration. Performance Indicators. Net Profit Margin. Performance Indicators. Accounts Receivable Turnover. Performance Indicators. Working Capital.

freshbooks.com - The 5 Most Important Financial KPIs That Drive Business Strategy

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Part of running (and growing) a successful business is establishing the right business strategy. And part of crafting the right strategy for your business is knowing which key performance indicators (KPIs) you should use to inform that strategy—particularly when it comes to your finances. A financial KPI can inform your business in many ways. For example, maybe you’re just getting things off the ground and rolling out your first strategic initiatives. You’ll need to measure the impact those initiatives have on your bottom line. Maybe you’re getting ready to take your business to the next level. You’ll need financial data to help inform your plans to grow and scale. Or, let’s say you’ve had a strategy for your business in place for some time—but you’re not sure if it’s helping you achieve your goals. Digging into the numbers will help you determine whether to keep things moving forward as-is or if your strategy needs an upgrade.

So, how, exactly, can you use financial KPIs to inform your business strategy? And what are some financial KPI examples that are the most effective for driving strategic decisions?

First, Define Your Business Strategy

A business strategy is a clear, measurable plan that outlines, in detail, how to take your business from where you are now to where you want to go. You can lean on your strategy to achieve your business goals (for example, launching a new product or expanding your business to a new market), but it isn’t the same as a business goal. If the goal is the destination, think of the strategy as the map to get there. When building a strategy, you’ll need to do the groundwork to: Clearly define your goals. Goals are the desired outcome—like becoming the top content marketing agency in the country. Goals are the desired outcome—like becoming the top content marketing agency in the country. Clearly define your objectives. Objectives are the specific, measurable steps you’ll take to achieve your goal. If your goal is to become the top content marketing agency in the country, objectives might include hitting X dollars in revenue or closing X clients by the end of the year. Once you can articulate your business goals and objectives, you’re ready to talk about how you’ll get there: the strategy. And what actions (also known as tactics) you’ll need to take—on a weekly, monthly, or quarterly basis—to get there. Continuing with the content marketing agency example, that might mean pitching X potential clients each month, setting up an inbound marketing strategy to bring new leads into your business, or publishing thought leadership articles to gain more notoriety.

Long-Term vs. Short-Term Financial KPI Comparison

There are certain KPIs to monitor day-to-day to keep your business on track. These shorter-term KPIs, like operating cash flow, days sales outstanding, or current ratio, will give you key insights into the current financial health of your business. They can help you determine your next best step and how to keep your business moving forward in the immediate future. But if you want your business to succeed in the long run, you’ll need to look at KPIs that inform long-term strategy. The data you uncover with these KPIs can help you:

Determine whether you’re on track to reach your financial goals

Evaluate the success of your strategy

Identify any opportunities and challenges

Assess whether your customers are happy or not

Not All KPIs Are (Just) Financial

While financial metrics are important, you’ll also want to look at other KPIs. This includes KPIs that measure your team’s effectiveness (such as staff advocacy score) or customer satisfaction and loyalty (such as net promoter score). These KPIs can give you invaluable insights into your business. And though they’re not technically financial ratios, they can directly impact your revenue. So they’re also helpful from a financial standpoint.

The 5 Most Useful Financial KPIs for Business Strategy

Whatever your business goals, there are some financial key performance indicators you should be continually tracking and using to inform your business strategy. Other metrics beyond these financial KPI examples may also be helpful. But these are fundamental. For each financial KPI, note the performance indicators that explain how to use the data. This helps you understand a good result versus something that needs improvement and how it could affect your business strategy.

1. Sales Growth Rate

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Sales growth is one of the most basic barometers of success for a business. By monitoring the growth of your sales over time, you can identify which elements of your strategy are positively impacting sales and which are falling flat.

The formula to calculate sales growth rate is:

Performance Indicators

You always want this KPI to be a positive percentage. That means your overall strategy is working. If your sales growth rate is negative, something about your strategy isn’t connecting with your customers—and it’s time to make a change. For example, you own a restaurant and introduce one change in Q1: a new menu. If the net sales for your new menu in Q1 were $10,000—but the net sales in Q4, with your old menu, were $15,000—your sales growth rate would be -33.33%, or:

($10,000 – $15,000 / $15,000) x 100

Your new menu isn’t driving the results you’re looking for. Now you can take steps to increase sales—for example, reverting to your old menu or putting more effort and resources into promoting your new menu to customers.

2. Revenue Concentration

The best use of your time, energy, and resources are often the clients, customers, and projects that drive the most revenue for your business. That’s why revenue concentration is another must-track financial KPI for your business. Revenue concentration helps you identify how much revenue each client or project produces for your business as a percentage of your total revenue. Using this financial KPI, you can determine the ROI for each client. Calculating revenue concentration starts by analyzing your revenue streams. (Your FreshBooks Dashboard provides at-a-glance summaries of your income streams, making it easy to analyze them by client or service.) Once you know how much revenue each client, project, or service is bringing into your business, you can use that data to calculate your revenue concentration.

The formula to calculate revenue concentration is:

Revenue Concentration = (Revenue by Customer or Project / Total Revenue) x 100

Performance Indicators

When you know which customers, clients, or projects are driving the most revenue (and which are not), you can shape your strategy around serving the clients and/or projects that will be the most financially lucrative. For example, you own a copywriting business, and after analyzing your revenue streams, you realize that 80% of your income comes from white papers, while only 20% comes from other projects like blog posts or website copy. So white papers are your big money-maker. Now you have data that supports focusing more aggressively on marketing your white paper writing services to potential clients. Or maybe, after calculating this KPI, you realize that 75% of your revenue is coming from a single client. That’s a risky situation for a business owner. If you lose that client, you also lose most of your income. In that situation, you could adjust your business strategy to focus on diversifying your client portfolio and spreading your revenue across a wider roster of clients.

3. Net Profit Margin

Profitability is one of the most important indicators of a company’s financial health. If you want your business to succeed in the long run, you need to be generating profit. While several different profitability ratios can be useful—including gross profit margin and operating profit margin—net profit margin is a must. Net profit margin measures how much profit your company makes after expenses. That includes operating expenses (like rent and utilities) and non-operating expenses (like taxes and debt payments). Strategically speaking, the net profit margin gives you the bottom-line view of how profitable you are. If your business isn’t profitable, something needs to change.

The formula to calculate net profit margin is:

Net Profit Margin = (Net Income / Revenue) x 100

Performance Indicators

Simply put, if your net profit margin is positive, you’re generating profit. You can either keep doing what you’re doing or adjust your strategy to increase your profitability. On the flip side, if your net profit margin is negative, you know your business is losing money. You’ll need to overhaul your business strategy to get your net profit margin in the green. That might include cutting costs, raising prices, acquiring more clients, or finding better clients.

4. Accounts Receivable Turnover

If your customers are dragging their feet and paying their invoices late (or not paying them at all!), it can seriously harm your financial health. That’s why the accounts receivable turnover (a.k.a. debtor’s ratio) is an important KPI. It measures how well your clients pay their invoices within an allotted timeframe (for example, net 30 or net 60).

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The formula for calculating annual accounts receivable turnover is:

Accounts Receivable Turnover = Net Annual Credit Sales ÷ Average Accounts Receivable

The KPI requires you to know your net credit sales, which are any amounts not paid upfront in cash. So, for a project-based business, that would typically be the payment owed for the completed project minus any retainer or fees paid at the start of the project.

It also requires you to calculate your average accounts receivable. That is:

(Beginning Accounts Receivable + Ending Accounts Receivable) ÷ 2

The accounts receivable turnover ratio shows you how many times your accounts receivable turned over in the time period you’re measuring. By calculating your accounts receivable turnover for a year and dividing 365 days by the number of times per year your AR turns over, you will see how many days on average it takes for you to receive payments.

Performance Indicators

The higher your accounts receivable turnover, the fewer past-due invoices in your accounts on average, and the better your cash flow. It can also indicate that you have an efficient process for collecting payments from clients. Lower isn’t always better with this KPI. Maybe your business can do just fine with payments within 15 or 30 days—and giving clients time to pay may contribute to customer retention. So, as long as the average number of days it takes your clients to pay is within that period, all is well. If your accounts receivable turnover is too low—and customers take too many days to pay—you may start facing cash flow issues. To address the problem, you may need to examine your invoice payment terms, explore different payment methods, or take other actions to get paid faster.

5. Working Capital

As a business owner, you need cash to operate. This cash is called working capital, and it helps you meet your short-term financial obligations that keep your day-to-day operations going. Understanding your working capital ratio will help you plan your future strategic moves, like hiring new team members to scale your business or investing in new equipment. It will also alert you to when you need funding to keep your business moving forward. Working capital is calculated by comparing the company’s current assets to its liabilities. The formula for calculating working capital is:

Working Capital = Current Assets – Current Liabilities

Performance Indicators

If you have more assets than liabilities, you have positive working capital—which means you have enough cash on hand to cover your liabilities plus additional funds left over. On the flip side, if your liabilities are more than your assets, you have negative working capital. That means you don’t have enough money on hand to cover your financial obligations. Both positive and negative working capital can give you key insights into the state of your business and the success of your business strategy. For example, if your working capital is extremely high (your assets far outweigh your liabilities), you’re not investing enough money into your business. You might create a business strategy to use some of your working capital to expand or target new clients in that scenario. On the other hand, if you have negative working capital, you don’t have enough capital to cover your costs. You’ll need to adjust your strategy to focus on bringing more capital into the business—perhaps by applying for a business loan or increasing prices.

Use Financial KPIs to Drive Your Business Strategy

Hopefully, you now have a grasp on the most important financial metrics to track for your long-term financial health, how to calculate them, and what they signal about your existing business strategy. When used correctly, these financial key performance indicators can help inform how you work to achieve your business objectives. They’ll unlock insights that could easily be overlooked otherwise and ideally help your business grow faster and more effectively.

freshbooks.com - The 5 Most Important Financial KPIs That Drive Business Strategy

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