Imagine yourself 40 feet above the ground between two cliffs, arms outstretched for balance and keenly aware of every muscle flinching in your body as your feet grip the thin rope below you. Your balancing act requires intense focus on what’s ahead – never looking down, and certainly never looking backwards. Your leather-soled shoes grip the rope to prevent slipping and your arms are in overdrive, constantly making minor adjustments to counteract your body’s movements to maintain balance.
Unless you are from a remote Russian village or practice circus arts, you likely aren’t a funambulist (someone who walks a tightrope) and will never experience the adrenaline this type of sport provides. But as a business owner, you are walking a financial tightrope every day.
If you were to walk a tightrope, you have to know the forecast: will it rain? What’s the temperature? What’s the wind speed? Do I need to expect a flock of birds passing my way coming through from the north?
As a business owner, financial KPIs (key performance indicators) are like the weather report before you take another step on the tightrope – they let you know how things are currently going, and what to expect in the future. You can see financial trends and indicators that everything is going well or that something isn’t quite right. Don’t be caught off guard and get blown off your rope. It’s important to understand your finances and calculate these KPIs monthly when you receive the balance sheet from your bookkeeper.
If the idea of looking at the financial data, understanding it, and tracking monthly KPIs makes your pulse quicken like you are walking 40 feet in the air without a safety net, I’m ready to serve as your financial guardrails, helping you to keep your balance. I will keep an eye on your KPIs, giving you the support you need to keep yourself from falling when that sudden gust of wind threatens to topple you over. Contact me for a free financial guardrail consultation.
Why Are Financial KPIs Important?
For optimal business health, you should be tracking a handful of financial KPIs over time. These serve as indicators that should guide your decision making, helping you shift your balance when needed. If there is a change in these KPIs over time, you’ll need to dive deeper into your financial reports to uncover what is causing the shift and take action to get these back in balance.
It’s important to remember that financial reports are historical and indicate what’s already happened. Even so, you still want to monitor them, alongside other indicators, to give you an idea of what’s headed your way. KPIs help you to not be caught off guard by a big gust of “sales are down” wind, or a “market change” bird dropping.
Of course, KPIs are only meaningful if they are correct. It’s critical to ensure all of your business’ financial information is correct in your General Ledger before calculating KPIs… otherwise they are meaningless!
What Is A Good Benchmark for My Financial KPIs?
It’s tough to compare your financial KPIs to another business’ KPIs because industry data of this kind can be difficult to come by. But if you are able to get your hands on the data, you need to compare apples to apples and oranges to oranges. It does you no good to compare your business to a company twice your size or who has a different business model. As a Fractional CFO, I provide guidance on healthy KPIs based on your specific situation and how to adjust towards a better balance.
What Are The Most Common Financial KPIs?
There are a handful of key financial KPIs to track for your business. Understanding them is the first step in understanding how they can help you make successful business decisions.
1. Gross Profit is calculated by taking your total sales and subtracting cost of goods sold (COGS). The answer is expressed in dollars and you want the dollar amount to be more than all of your overhead expenses if you want to have a profitable business.
2. Gross margin is expressed in a percentage and is your gross profit divided by total revenue. You want to have a consistent gross margin month-over-month. Even if sales go down, your COGS should go down too, so that your gross margin remains the same. If gross margin is not consistent, it could be an indicator that something is wrong with your bookkeeping or perhaps that you aren’t on the accrual basis of accounting. If your recordkeeping is correct, then you need to look into other causes before moving forward. Contact me to help solve the financial mystery.
3. Days Sales Outstanding, or DSO, is your average accounts receivable divided by total revenue during the same period, multiplied by the number of days in that period. This ratio is measured as a number of days and is an indicator of how fast you are collecting receivables. It reveals a cash flow problem if the number is too high. Ideally, this number is under 30 days, and is not good if it’s more than 60 days.
4. Inventory Turnover is the total COGS divided by the average inventory for the same period. This ratio reveals how fast your inventory is being sold. If you calculate this annually, you will know the number of times per year you have essentially sold your entire inventory. You want this number to be high, since a low number means you are tying up too much of your cash in inventory.
5. Working Capital is calculated by taking your current assets and subtracting your current liabilities. This reveals an answer in dollars and tells you how much capital you have available to make new investments or expand. This amount needs to be positive if you want the ability to invest back into your business (you do!). If it’s negative, you are probably going to have to borrow from a bank line of credit or take on debt.
6. Current ratio (or Working Capital Ratio) shows you how much in liquid assets you have available to pay short term liabilities. This ratio is calculated by taking your current assets divided by your current liabilities. A good ratio here is greater than 1 because you want more assets than payments you need to make. Anything under 1 is not great.
7. Debt to Equity ratio is the total liabilities divided by total equity and reveals how much of your business is financed by debt versus financed by equity (previous earnings or owner’s investment, for example). Most small businesses don’t have a lot of debt (which means this number will be small). The higher the debt you have the larger the debt to equity ratio. This ratio shows how important debt is to your company in order to facilitate business on a regular basis. The higher the number, the more risky your business. If your number is low, then you probably are not taking advantage of debt to run your business. A Fractional CFO like me can help solve this financial mystery – what’s a good number for your debt to equity ratio?
8. Cost to Acquire a Customer, or CAC, is calculated by adding all of your sales and marketing costs together and then dividing that by the quantity of new customers gained during that same time period. A caveat to this ratio is that you are presuming marketing costs have an immediate ROI, which we all know it doesn’t. For example, your Google Ad spend in August and the number of customers who sign up in August are associated with that same cost… but it can take as many as seven times to touch someone before they are ready to buy. But if you are consistently spending, you are likely to have a relatively consistent CAC number (presuming your marketing is doing its job). Even if it’s not 100% accurate, it’s good to know how expensive it is to acquire a customer. For example, if it costs you $2,500 to acquire a new customer, you want to be sure that you are getting that back when they buy from you. If you only earn $100 back from that customer, you have a huge problem!
Balancing Financial KPIs For Business Success
Balancing your business finances is critical for long-term business success. If you feel like you are walking a tightrope without the proper training or forecasting (watch out for that bird!), the first step is understanding your financial statements. After that, you need to know what KPIs to calculate and how to interpret them. Not only do I put up financial guardrails to help business owners keep their balance, but I also teach them the skills needed to walk the financial tightrope with confidence. Contact me today to set up a free financial guardrail consultation, with balance training!
