In my previous article about budgeting, javelin thrower Mr. A aimed to break the magical 90-meter barrier at least a month before the Olympics at a home competition. Mr. B's main goal was exactly the same, but in addition, he set annual, quarterly, and monthly milestones for himself. But how would he measure his progress as simply and efficiently as possible?
Key performance indicators
An athlete's training milestones consist of goals concerning speed, strength, endurance, nutrition, and rest. When smaller parts are in balance, the athlete is likely to achieve the main goal without unwanted injuries.
A company's balance and financial operating conditions are typically examined through three perspectives: profitability (speed and strength), liquidity (endurance), and solvency (nutrition and rest). Today, as cash-based thinking rises, working capital (mobility) KPIs are often included in the review.
In this article, I create an illustrative overview of a company's key financial metrics. You'll learn what benefits can be achieved through KPI-related goals and their monitoring, and how to explain KPIs to others in plain language.
Profitability and efficiency
In sports, speed measurement often involves comparing short-term maximum speed or average speed over longer distances. Instead, strength levels are often measured through maximum strength and strength endurance. In business, profitability metrics are similarly divided into revenue-related margin metrics and capital-related return metrics.
Gross margin, EBITDA, and operating cash flow are metrics derived from revenue. By examining them, short-term profits and margins can be determined, for example, monthly. Capital-related return metrics are used for longer-term reviews, such as fiscal year or rolling 12-month margins.
Revenue-related margin metrics
- Euro and percentage gross margin, EBITDA, and operating profit, as well as derived internal margins for measuring margins of specific product or service groups.
- Revenue per employee for efficiency measurement.
- Operating cash flow shows the cash impact of operations, which is one of the most important things to monitor.
- If the company belongs to a group or has extraordinary one-time items, net profit and total profit should also be examined.
Capital-related return metrics
- Return on equity %
- Return on investment %
Liquidity
To illustrate poor liquidity, imagine a 100-meter runner who can only run hard for 50 meters and then watches other runners' backs. It seems clear that the runner should adjust goals using endurance metrics instead of explosive speed and strength metrics.
Liquidity metrics are typically divided into static liquidity and balance sheet ratio KPIs (quick and current ratio) and dynamic liquidity and cash flow KPIs (operating cash flow and operating margin). Compared to endurance, quick ratio and current ratio describe the company's baseline condition, and operating margin describes its development.
Solvency
The balance of nutrition and rest creates the foundation for a runner's continuous development. If nutrition and rest are not balanced, speed and endurance development will inevitably stop. The following KPIs describe a company's solvency, "the runner's nutrition and rest".
Financial structure KPIs
- Equity ratio %
- Net gearing %
- Relative indebtedness %
Dynamic KPIs describing financing adequacy
- Interest-bearing net debt / EBITDA
Working capital
It's important for an athlete to have the opportunity to train freely and diversely. Similarly, working capital agility is beneficial in business. If too much cash must be tied up in inventory, customer financing through long payment terms, or supplier financing through minimal payment terms, the company's cash situation quickly becomes strained.
Key working capital KPIs
- Accounts receivable turnover
- Accounts payable turnover
If operations require inventory, then also
- Working capital %
- Net working capital %
- Inventory / Revenue
Summary
The noble art of utilizing KPIs belongs to every business professional's repertoire. In short, when milestones are carefully monitored at the management level, all parties are aligned, the company's operational capability grows, and financial risk decreases. Reactivity gives way to proactivity, meaning different scenarios can be prepared for in advance.
HR management also hits its target better when there's a clear picture of the company's financial situation. Milestone tracking itself signals to staff that the company is in safe hands. Note that company milestones can be turned into incentives for staff. All this motivates and engages staff, which usually shows in results.
