A guide on why financial metrics matter
With many businesses quick to adopt Cloud accounting software, finance functions today have access to data at their fingertips to key insights and analytics to allow them to measure the impact of financial activity on the business.
While the right financial metrics may seem difficult to establish, they have been critical to understanding and improving processes and operations within businesses during recent times. 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?
Without clear metrics for informed decision-making, you can end up making critical decisions based on gut feelings, opinions, or untested hypotheses, which is not the most strategic or defensible approach.
CFOs and Finance Directors must therefore ask themselves:
- What financial metrics do I want to measure?
- What information I am looking to gain and report?
- How can I utilise information provided by these financial metrics to make informed and strategic decisions?
Metrics play a critical role in understanding and improving processes and operations within your organisation.
We have devised a guide to help you understand the different purposes and insights these numerous financial metrics can provide you and your business. Remember, knowledge is power and having the right figures is paramount for business success and strategy.
What is a metric in business terms?
A quantifiable target measure set by a business to track its performance. Metrics are used to assess and compare against benchmarks or specific projects to determine what performance looks like, within any given set timeframe.
What is a growth metric?
A specific target set with focus placed on the underlying growth of a business. Growth metrics can include revenue, the average customer spend or the number of active users.
Why are key performance indicators (KPIs) used?
Businesses can use KPIs to forecast or predict future performance. A glance into the future can help businesses evaluate progress, make adjustments, and manage their long-term goals.
How are KPIs used in finance?
There are two common uses for financial KPIs. The first one is financial reporting, where your business conveys information to shareholders. The second use is for internal auditing and process improvement.
What metrics can be used in finance?
Operating cash flow
An essential metric for every business entity. This KPI is also used in comparison with the total capital you have in use via an analysis that reveals whether your operations are generating sufficient cash for support of capital investments you are making to advance your business.
Positive cash flow keeps your business alive and helps you make a profit. Every business needs cash inflow to survive, earn revenue and achieve growth.
Cash flow available for debt service
Opportunities to invest in your business can come quickly. You need to be ready to understand your cash flow available for debt service (CAFD) at a moment’s notice. This is the amount you can comfortably pay for a new loan or other financings for your business after you’ve accounted for all your other costs.
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 annualized growth rate. The sum of growth and profit percentage should be greater than 40.
Profit and loss
Used to keep track of your business revenue and expenses over a specified period of time. As a CFO, you need to know if your revenue is translating into actual income. Your profit and loss are also a great indicator of growth over time in maintaining the business budget and reaching profitability.
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.
This KPI divides total assets by liabilities to give you an understanding of the solvency of your business. It provides an 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.
Debt to equity ratio
This critical KPI helps you focus on your financial accountability. The ratio is calculated by looking at your business's total liabilities in contrast to your shareholders' equity (net worth). The number indicates how profitable the business is.
It tells you and your shareholders how much debt the business has accrued in effort to become profitable. A high debt-to-equity ratio reveals a practice of paying for growth by accumulating debt.
Accounts payable turnover
This shows the rate at which your business pays off suppliers. The ratio is the result of dividing the total costs of sales during a period (the costs your company incurred 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 the length of time your company is taking to pay off its suppliers is increasing and that action is required in order to keep your good standing with your vendors, and to enable your business to take advantage of significant time-driven discounts from vendors. At this point some businesses can choose to consider financial restructuring.
Accounts receivable turnover
The accounts receivable turnover KPI reflects the rate at which your business is successfully collecting payments due from your customers. This KPI is calculated by dividing your total sales for a period by your average accounts receivable for that period.
This number can serve as an alert that corrections need to be made in managing receivables, to bring payment collections within appropriate timeframes.
Inventory continuously flows in and out of your production and warehousing facilities. It can be hard to visualize the amount of turnover that is actually taking place.
The inventory turnover KPI allows you to know how much of your average inventory your company has sold in a period. This KPI is calculated by dividing sales within a given period by your average inventory in the same period. The KPI gives you a picture of your company's sales strength and production efficiency.
Return on equity
The return on equity (ROE) KPI measures your company's net income in contrast to each unit of shareholder equity (net worth). By comparing your company's net income to its overall wealth, your ROE indicates whether or not 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 optimized to grow the business.
This is the measurement of your company’s wealth and financial flexibility. It is understood as a more conservative evaluation of a business's fiscal health than the current ratio, becausthe e calculation of the quick ratio excludes inventories from assets.
It is a quick and easy way of assessing the wealth and health of your company. 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.
Throughput time is the time it takes the business owner to move the customer through the process from start to finish. Knowing this metric is critical to efficiently operating your business. Examining this one metric can help you identify ways to speed up the throughput of the business.
Used to determine how much money is your business spending in a given month. To effectively grow a business, you need a firm understanding of how much your business is spending, where you’re spending it and whether you can save money by streamlining inefficiencies.
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.
Looking at lifetime value enables you to spend wisely on the customers who will be valuable to your business well beyond their latest transaction.
Why should financial metrics matter to you?
Planning, analysis and metrics in reporting have always played a critical role in finance. However, for many, it has taken the pandemic-driven crisis for CEOs and board members to fully appreciate the benefits of real-time quality financial reporting.
Businesses that know what metrics to use and what they will measure will be able to manage uncertainty and reduce risk when making decisions. In turn, this leads to a more prosperous business and a faster rate of growth by allowing you to make more confident, long- and short-term decisions about your business.
This also gives you the opportunity to surpass and outmaneuver competitors who fail in this area. By capturing and monitoring data, you're able to make sophisticated, well-informed decisions; something your rivals do not possess. This can then be used by management to navigate the business through both good times and uncertain and volatile periods. In fact, the most valuable companies in the world use data in this way.
A key part of their success is their ability to use the data they collect to drive the business forward. In an increasingly competitive global marketplace, understanding your key performance metrics such as product profitability, cash flow, customer preferences, staff productivity etc provides you with a vital competitive edge.
It's time to go beyond the limits of traditional reporting and reap the rewards of utilising financial metrics through customisable reporting with real-time access to your data.
Our cloud-based accounting solution provides you with instant access to the data and metrics you want to measure, with automated reporting so you can make agile, strategic decisions. This software also possesses functionality for your wider business needs, and is particularly suitable for small to medium-sized manufacturers that are looking to grow.