How to Choose & Track Important Financial Performance Measures for Healthy Businesses
There are many financial performance metrics you can utilize to better understand your business. Some analysts employ dozens of these key performance metrics (KPIs) to measure a business’ health.
Most small business owners do not have a lot of time to pore over this sort of data. There is also a risk that by putting too much stock in the wrong metrics you may end up with misleading information.
Here is a guide to help you decide which KPIs you should choose to better understand your business and how to utilize them to keep your company healthy.
Before deciding which financial performance indicators will be the most helpful, you should identify your company’s financial goals. Then you can think about what KPIs will help achieve those goals.
For example, if you’re trying to expand your business, you can use the current ratio formula. The current ratio divides your assets by your company’s liabilities. This gives you an idea of how well you are positioned to pay debts. It also helps you understand if you can offset the cost of expansion with your present income.
Look for the parts of your business that seem like they can be improved. By applying performance metrics to these areas, you can find patterns that can be fixed.
If your business moves through a lot of product, an inventory turnover KPI can be helpful. This KPI divides your sales by your inventory using the same timeframe. Seeing the numbers from this equation will help you understand how efficient production and sales are.
Labor Productivity Ratio
The labor/productivity ratio KPI can help assess your labor costs. This metric takes the output of your production in dollars and divides it by the number of hours of labor required. This can also help you decide whether the initial cost of automating a procedure will be more cost-efficient in the long term.
Operating Expense Ratio
Even if you feel your business is doing well, it can still be threatened by a strong competitor. Take control of your relationships with rivals in your industry by utilizing KPIs to see where you stand.
Compare your operating expense ratio to industry standards to see if you need to tighten-up. This KPI takes your operating expenses and divides it by your total revenue. By doing this, you can see if you’re spending more than your competitors.
Percentage of Returns Ratio
You can also use KPIs to contrast the overall profitability of your company. The percentage of return on assets takes your net profits and divides it by the number of sales multiplied by 100. This allows you to see how efficiently your company uses resources. It also lets you understand if a competitor is performing more efficiently, so you can assess what you can do to remain competitive.
Your business may be turning a profit, but it doesn’t mean you shouldn’t utilize financial performance measures to monitor the pulse of your organization. Even established companies can go under if unexpected problems interrupt normal operations.
If your business has debts, you can use the debt-to-asset ratio to measure your ability to resolve those debts. This simple performance metric divides your debt by your assets. If the resulting ratio is less than one, it indicates that your company can repay the debt.
You can also use the quick ratio to gain a simple understanding of your business’ wellbeing. The quick ratio works much like the current ratio; it divides assets by liabilities. However, the quick ratio excludes inventory from your assets, so it’s a more conservative financial performance indicator of your company’s liquid assets. You can then detect any disturbances in your normal operations and fix minor issues before they cause serious problems.
Get the most out of the data you have by tracking these important financial performance indicators.
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