- About ANSA
- Contact Us
Profitability is just one aspect of performance management. There are many other such Financial and Non-financial measures that are used to measure performance. Modern management uses a combination of both these types to ensure that organisational performance is measured in a rounded manner.
Some of these measures are identified as being very critical to the existence and success of the organisation. Such measures are called ‘Key Performance Indicators’. Effectively, KPIs measure the level of performance in the Critical Success Factors (CSFs) of the entity (i.e., how well they are achieved).
Key performance indicators (KPIs) can appear a bit intimidating for the uninitiated ones due to the large number of options for a variety of categories, such as profitability, liquidity, solvency, efficiency, and valuation and the varying implications of each measure.
You need to have developed sufficient knowledge of these metrics in order to:
– Identify the correct KPIs to be used to evaluate the achievement of relevant CSFs.
– Use the implications of the KPIs’ results to make recommendations to the management or conclude better business decisions from both financial and non-financial perspectives.
This article focuses on the Financial Performance Measures – to help you understand KPIs better and how you can make use of the metrics to improve your company’s financial performance. Here is a list of the 8 basic, key financial performance indicators managers need to know and monitor internally.
– Gross Profit Margin: This is a profitability ratio that measures the amount of revenue made from sales after subtracting the cost of goods sold (COGS).
– Net Profit Margin: This measures how much net profit is generated as a percentage of revenue after subtracting all costs for the business, including costs of goods sold, operating expenses, interest, and taxes.
– Return on Equity: It is a profitability ratio preferred more by the equity investors that is measured by dividing net profit over shareholders’ equity. It indicates how well the business can utilise equity investments to earn profit for investors.
– Operating Cash Flow: Refers to the amount of money generated by business operations.This will indicate whether a company can generate sufficient cash flow to maintain and scale its operations or requires additional financing to maintain its current operations.
– Current Ratio: Sometimes known as the working capital ratio, this is a liquidity ratio that helps a business to determine whether the business can pay its short-term obligations or those due within one year, measured by dividing the current assets (cash, accounts receivable, inventories of raw materials and finished goods) by the current liabilities (accounts payable and debts).
– Quick Ratio: Also known as an acid test ratio, it calculates a business’s ability to handle short-term obligations. This uses only highly liquid current assets such as cash and accounts receivable etc. as an improved measure over Current Ratio.
– Inventory Turnover: It measures how many times all the inventory is sold per accounting period and whether the business has sufficient inventory proportional to its sales.
– Debt-to-Equity Ratio: The debt-to-equity ratio is a solvency ratio that measures how much a company finances itself using equity versus debt (i.e, how geared it is).
Before managers can begin to improve financial performance, there must be an understanding of the main strategies aka best practices to achieve successful KPIs. There are a few best practices a manager may employ and they are setting enough financial performance indicators, setting the right performance indicators and benchmarking the performance indicators.
Setting enough performance indicators will help employees to focus on achieving the required financial performance which is then measured. The corollary here is that ‘Whatever gets measured gets done’ and the good news is that employees will not ignore performance indicators because they are assessed by the company.
Managers also need to set the right performance indicators as it imparts an impression about the company’s leading indicators and the most important ones. It is crucial for managers to focus on the right KPIs and significantly improve what was lacking to increase the financial performance of the company.
Lastly, KPIs should be benchmarked. Benchmarking is used to do comparisons between past and current financial performance or with competition. It is important to be consistent as intra-period comparisons lose meaning if different measures are used in different periods.
The benefits of using KPIs for benchmarking against external factors start to face issues due to the same reason that different organisations may use different types of indicators or even different variants of the same measure (such as Debt/ Debt+Equity as a measure of solvency).
KPIs for that matter or any goal, should be SMART (Specific, Measurable, Achievable, Realistic, Timely) so that employees can aspire to accomplish. No one wants to spend time or effort on ineffective and difficult KPIs.
In summary, managers want to be seen as implementing the best KPIs that help determine, track, and improve the financial performance of a business, and at the same time, achievable by its employees.