18 Financial KPIs that Startups Should Use to Manage Finances and track Performance
KPIs measure an organization’s progress toward its objectives and tell the story of how well a company is performing. But with the vast amount of information available, which metrics are most crucial to track success?
The immense amount of information available to decision-makers today can also be overwhelming, the enterprise accounting software organization Netsuite recently published an ebook on a number of important metrics to track.
What Are Key Performance Indicators
Key performance indicators (KPIs) are quantifiable business metrics that track and measure an organization’s progress toward its strategic objectives. More than just numbers, KPIs tell a story about how well a company is performing. Understanding KPIs as they relate to your industry, company and even separate departments within a company is essential for any growing business.
This article will go into why KPIs are important, what are the characteristics of a good KPI and provides a list of popular financial and operational KPIs. High-level KPIs focus on a company’s overall performance, while lower-level KPIs focus on departmental processes, products and productivity. According to the Netsuite whitepaper, they suggest that a company should focus on no more than around 10 KPIs as a general rule. No matter what business you’re in, investors will expect you to be on top of certain metrics. Not every data point is a KPI. Focus on critical startup metrics that will really help you evaluate your business. An article in Silicon Valley Bank suggests every startup needs to understand its unit economics, customer acquisition cost, customer lifetime value and payback period. Now depending if you are a services-based business, a retail storefront, an eCommerce or an investor-backed software startup, the KPI metrics may be different, or not all will be relevant to tracking your success.
There are many different types of KPIs
Many focus on financial performance metrics, such as revenue growth rate and net profit margin. Others focus on customers, such as customer satisfaction or customer churn. Some KPIs measure operations, such as time to market and average order fulfillment times, while others concentrate on employee or talent management metrics, such as workforce retention and turnover.
KPIs fall into two categories:
- Leading indicators – predict what may happen in the future and offer businesses the opportunity to prepare accordingly. For example, an increase in deal size or employee headcount may portend revenue growth.
- Lagging indicators – reflect past results, measuring the aftermath of actions. Monthly recurring revenue and employee turnover are two examples of this type of KPI. Lagging indicators can uncover trends, help companies evaluate their progress and influence future decisions.
10 Popular Financial KPIs
While organizations need a firm grasp of what will make them successful and which industry-specific KPIs matter to them, there are metrics relevant to most businesses. Here are 10 popular financial KPIs used by growing businesses.
- Gross Profit Margin – measures the amount of money left over from product sales after subtracting cost of goods sold (COGS). A higher gross profit margin indicates the company is efficiently converting its product or service into profits. The cost of goods sold is the total amount to produce a product or service, including materials and labor. Net sales are revenue minus returns, discounts and sales allowances.
Gross profit margin = Net sales – Cost of goods or services sold / Net sales x 100
- Operating Profit Margin – shows the percentage of profit a company makes from operations before subtracting taxes and interest. Increasing operating margins can indicate better management and cost controls within a company. Gross profit minus operating expenses is also known as earnings before interest and taxes (EBIT).
Operating profit margin = Gross profit – Operating expenses / Revenue x 100
- Operating Cash Flow (OCF) – is the amount of cash a company generates through typical operations. This metric can give a business a sense of how much cash it can spend in the immediate future and whether it should reduce spending. OCF can also reveal issues like customers taking too long to pay their bills or not paying them at all.
Operating cash flow = Net income + Non-cash expenses – Increase in working capital
- Working Capital Ratio – measures the liquidity of a business to determine if it can meet its financial obligations. A working capital ratio of 1 or higher means the business’s assets exceed the value of its liabilities. Companies often target a ratio of 1.5-2, and anything below 1 signals future financial problems. The working capital ratio is also known as the current ratio.
Working capital ratio = Current assets / Current liabilities
- Quick Ratio – also called the acid test ratio, measures whether a business can fulfill its short-term financial obligations by evaluating whether it has enough assets to pay off its current liabilities. Quick ratio is written as a number, with a ratio of 1.0 meaning a company has just enough assets to cover its liabilities. Anything below 1 could mean the company’s business model is not viable.
Quick ratio = (Cash + Marketable securities + Accounts receivable) / Current liabilities
- Return on Assets (ROA) – measures the profitability of a business compared to its total assets. This return on investment (ROI) metric shows how effectively a company is using its assets to generate earnings. A higher ROA means a business is operating more efficiently. To calculate average total assets, add up all assets at the end of the current year plus all the assets from the prior year and divide that by two.
ROA = Net income / Average total assets
- Days Payable Outstanding (DPO) – the average number of days it takes a company to make payments to creditors and suppliers is days payable outstanding. This ratio helps the business see how well it’s managing cash flow, and whether it’s taking advantage of discounts for early or on-time payments from vendors. To calculate DPO, start with the average accounts payable for a given time (could be a month, quarter or year). Average accounts payable = Accounts payable balance at beginning of period – Ending accounts payable balance / 2
DPO = Average accounts payable / Cost of goods sold x Number of days in accounting period
- Days Sales Outstanding (DSO) – this metric shows how long it takes, on average, for customers to pay a company for goods and services. A higher day sales outstanding indicates a company takes longer to get paid, which can lead to cash flow problems. Generally speaking, the lower your DSO, the better.
Days sales outstanding = Accounts receivable for a given period / Total credit sales x Number of days in period
- Cash Runway/Burn Rate – shows how long a company has before it runs out of cash based on the money it currently has available and how much it spends per month. The cash burn rate metric helps businesses understand when they need to cut back spending or get additional funding. If your cash runway shortens over time, it’s a sign your company is spending more money than it can afford to. Cash runway is closely tied to burn rate, which measures how much money a company spends over a certain period (usually monthly). Burn rate is frequently used by investor-backed startups that lose money in their early days.
Monthly burn rate = Monthly expenses – Monthly revenue
Cash runway = Cash balance / Monthly burn rate
- Budget vs. Actual Variance Analysis – compares a company’s actual spend or sales in a certain area against the budgeted amounts. Although budgets and expenses are related, budget vs. actual can be used to compare both revenue and expenses. This “budget variance analysis” helps small business leaders identify areas of the business where they’re overspending that may need further attention. It also reveals areas of the business that outperformed expectations.
Budget variance percentage = Actual / Forecast − 1 x 100
8 Common Operational KPIs
Operational KPIs show how well your business is running. Improved internal business processes and metrics lead to more satisfied customers, which is imperative for growing businesses.
- Cost Per Unit – is how much a single unit of product costs a company to produce or buy. It is best used in companies that manufacture or sell large amounts of the same product. Knowing the cost per unit helps companies understand if they are making products in a cost-effective manner, how to price products and when they’ll turn a profit.
Cost per unit = (Fixed costs + Variable costs ) / Number of units produced
- Lead Time – measures the amount of time that passes between the beginning and end of any supply chain process. This could be the time between a business ordering a product from a supplier and receiving it, between a customer placing an order and receiving it or between the start and end of a production process. This KPI measures the efficiency of the entire supply chain or certain steps within it. Lead time is important because it impacts the amount of inventory a company needs to have on hand to fulfill orders. In that way, it indirectly impacts customer satisfaction. While the formula below is for total lead time, it can easily be adjusted to measure customer lead time, supplier lead time or production lead time.
Cumulative lead time = Order process time + Production lead time + Delivery lead time
- Cash-to-Cash Cycle Time – metric tells you the length of time between when you pay suppliers for materials and when your customers pay for the final finished product. You want the cycle time to be as short as possible. Tracking this metric will help identify potential causes of cash flow issues. Although this metric varies depending on what you sell and your customer base, some of the most efficient companies have cash-to cash cycle times of less than one month.
Cash-to-cash cycle time = Receivable days + Inventory days – Payable days
- Inventory Turnover Rate – also known as inventory turnover ratio or inventory turn, inventory turnover rate is the number of times a company sells and replaces its stock in a certain time frame, usually one year. Businesses can use the inventory rate to determine if they’re carrying too much inventory compared to how much of its stock is selling. Inventory turnover rate measures how well a company makes sales from its inventory.
Inventory turnover rate = Cost of goods sold / Average inventory
- Sell-Through Rate – is a comparison of the inventory amount sold and the amount of inventory received from a manufacturer. Sell-through rate is important because it helps you understand how efficiently you’re selling through inventory. A high sell-through rate is positive because it means you’re moving product quickly. A low sell-through rate, on the other hand, is undesirable because it means you’re paying to stock excess inventory.
Sell-through rate = Number of units sold / Number of units received x 100
- Gross Margin Return on Investment (GMROI) – measures how much money a company makes on a specific inventory investment. Tracking this metric gives your company insight into which inventory items are especially poor or strong performers. In general, a GMROI of 200 to 225 is considered solid.
Gross margin return on investment = Gross profit / Average inventory cost x 100
- Lost Sales Ratio – is the number of days a specific product is out of stock compared to the expected rate of sales for that product. Companies can then use this number to calculate the money lost when a company runs too lean or experiences an unexpected surge in demand, leading to stockouts. Measured as a percentage, companies should be aiming for the lowest lost sales ratio possible.
Lost sales ratio = (Number of days product is out of stock / 365) x 100
- Unit Economics – knowing the price and cost of what you sell, however, will only get you so far. To understand whether you have a shot at building a sustainable business, a key will be your unit economics. Whether you sell physical products or monthly software subscriptions, this term refers to the profit you earn on each unit sold. Figuring this out is always complex, but can generally be boiled down to a simple formula consisting of three critical KPIs. One is the lifetime value of a customer (LTV), or the amount the average customer will spend with you over time. To determine LTV, you must divide the average spend of a customer over some time (month, quarter or year) by your churn rate, or how frequently customers stop buying from you. Next, dividing the LTV by the customer acquisition cost (CAC) — the amount you spend on marketing, promotions and incentives to win a new customer — provides you unit economics and a basic outlook on profitability. There is no single answer for what values these KPIs should have to prove your business is viable. But a rule of thumb is that if your LTV divided by your CAC is less than three, the business may not be worth pursuing because it may take too long for the company to become cash flow positive. Also, investors get nervous if the payback period, or the time it takes to recoup the CAC, is more than 12 months.
Lifetime value (LTV) / Customer Acquisition Cost (CAC) >- 3
How to Choose the Right KPIs for Your Business
Before a business can select any of these KPIs, it must first establish its overall goals. Only then can it know what aspects of the business and functions on which to focus. From there, choosing the right KPIs helps an organization gauge whether it’s on track to achieve its business goals. But what does a good KPI look like? What characteristics should you look for? Consider the following criteria:
A strong KPI reflects a business’s strategic goals. Goals will vary by the type of company, such as business-to-business (B2B) or business-to-consumer (B2C), and business model. A software company, for instance, will have different measures of success than an industrial manufacturer. If the goal is to increase ecommerce revenue by 30%, a company might choose metrics that measure average order value, conversion rate and cart abandonment. KPIs can also align to the goals of different departments, teams and individuals. If the purchasing department wants to improve inventory management, the most effective KPIs might include inventory turnover rate and perfect order rate.
A good KPI also matches where a business is in its life cycle. The metrics for a growing business, for instance, might center on customer feedback and business model validation. KPIs for more established companies could be monthly recurring revenue, customer retention and customer acquisition cost.
Quantifiable and measurable
Good KPIs are easy to measure and based on clear, trackable goals. They can be expressed as ratios, percentages or rates, so teams can see at a glance where they stand and where they need to go. For example, “lower customer acquisition cost by 15%” is a measurable goal, but “lower customer acquisition cost” is far less so. KPIs for this goal might include conversion rate and lead generation cost by channel.
Does the KPI concentrate on what truly matters to move the business forward? Or does it focus on surface-level vanity metrics that appear to cast a product or the business in a successful light, such as the number of downloads for a free app or social media followers? In most cases, the majority of these users will not become paying customers, so the value is limited. The right KPIs offer value, point to a trend or inform next steps.
A good KPI measures achievable goals rather than unrealistic targets. Attainable also means the data needed to calculate the KPI is available, accessible, trusted and presentable to stakeholders.
An actionable KPI indicates measurable tasks that lead a business toward its goals. Without a goal, the KPI is just a metric, not an indicator. KPIs can inform decisions, such as whether to adjust a sales plan based on how well a product is performing in the market. They also reveal trends that impact future strategies.
The Difference Between Metrics and KPIs
While the terms metrics and KPIs are often conflated, each has a distinct meaning.
Metrics are any quantifiable data a company monitors to track performance and improvements across the business. Once an organization starts tracking an important metric, it has a baseline against which it can compare future numbers to see how the performance of various processes or teams has changed over time. As a business grows, it often starts tracking more metrics, including ones specific to certain initiatives or departments.
Key performance indicators are metrics that are particularly important to your business because they measure progress against critical company objectives. A distinguishing feature of KPIs is they usually have predetermined goals, which is not true of all metrics—a company might monitor certain metrics for years without specific targets in mind. At least a few KPIs are usually financial metrics, like revenue growth, profit margin, cash flow and customer acquisition cost.
In short, KPIs reveal if a business is achieving its primary objectives or targets. Metrics simply track the status of different processes that are of varying importance to the company.
Why do KPIs matter for your business? KPIs help companies achieve their short and long-term business goals and make adjustments to stay on track. They can help monitor company health. KPIs can be grouped in a variety of ways— organizational or operational, leading or lagging, and by customer, financials, growth, or process. Taken together, they indicate how well an organization is performing. KPIs can be used to measure progress on a company’s key business objectives. If one of a company’s goals is to increase annual sales by 20%, then KPIs like monthly sales growth and monthly sales bookings can help it gauge progress toward that goal. If need help deciding which are the important financial KPIs for your business that might be useful in giving you early confirmation of success or early alerts to potential problems, feel free to reach out to Huckabee CPA for a free consultation.