Key Performance Indicators that Help You Assess Company Health
Key Performance Indicators (KPIs) are metrics used by managers and financial professionals to assess the health of a company.
Think of KPIs as the vital signs to check on the health of a company. When a person goes for a medical checkup, the doctor will take his or her vital signs and, based on those numbers, make a quick assessment of the person’s overall health. Depending on the results, deeper analysis into a specific area might be required to find the root cause of the abnormal reading.
In the same way, KPIs represent a handful of numbers that give the management team a picture of the overall health of the company. If certain numbers show signs of a problem, the team can dig deeper to specific areas of the company to find the cause of the problem.
There are virtually an unlimited number of KPIs to choose from. KPIs can be used to measure everything going on in the company from the financial health of the organization to resource utilization to sales figures to marketing effectiveness. Each management team member should choose the KPIs that most affect their area of responsibility and monitor them regularly to assess how well they are doing.
Types of KPIs
KPIs are often described as either Leading Indicators or Lagging Indicators.
Leading indicators are measures that can help you predict future performance. For example, a rise in wholesale prices of your components would be a leading indicator of higher inventory costs and less profit in the future. Management could use this information to develop a plan to lower costs and increase sales.
Lagging indicators look back at past performance. For example, last quarter’s net profit is a lagging indicator that does not predict your performance this quarter but can be used to track growth against projected revenues and performance goals.
Why measure KPIs?
KPIs help managers track their performance over time with measurable indicators. The right mix of leading and lagging KPIs can serve as early warning signals of potential problems for the organization, giving the management team time to react. KPIs can also signal positive activity, giving the management team the ability to capitalize on market movements to their advantage.
Most KPIs are numerical values available from your ERP system. These numbers can be tracked using dashboards so that each manager can monitor the health of their department.
Every company is different, so choosing the right KPIs for you is a choice your management team must make. Also, the KPIs differ from industry to industry. For instance, the KPIs used for a manufacturing company won’t necessarily apply to a service company.
With that in mind, here are some common KPIs to help you get started.
Many of the key financial KPIs come from the three primary financial statements:
Balance Sheet – The balance sheet lists the company’s assets, liability, and owners’ equity at a specific time.
Income Statement – The income statement accounts for the company’s revenues, expenses, and profit/loss over a time period. The income statement shows gross revenue to the company less expenses, resulting in net income. The net income is either positive (gain) or negative (loss).
Cash Flow Statement – The cash flow statement tracks income and expenditures by operating, investing, and financing activities.
The following financial KPIs are commonly used to assess the company’s financial health.
Gross Profit Margin – This represents the percentage of revenue remaining after deducting the cost of goods sold. The gross profit margin does not include other expenses, like operating expenses, interest, or taxes.
Gross Profit Margin = 100% * (Revenue – COGS) / Revenue
Net Profit Margin – Similar to the gross profit margin but includes all costs to the business.
Net Profit Margin = 100% * (Net Income / Revenue)
Current Ratio – Shows the liquidity of the company by dividing the value of its short-term assets (those that can be sold within one year, including cash, accounts receivable, and inventory) by the value of its short-term liabilities (those that must be paid within a year including short-term loans and accounts payable). A value greater than 1 indicates the company can quickly convert assets into sufficient cash to pay down its short-term debt.
Current Ratio = Current Assets / Current Liabilities
Quick Ratio – Is similar to the Current Ratio, but it omits inventory from the company’s current assets. The Quick Ratio, sometimes called the Acid Test, is sometimes preferred over the current ratio because inventory cannot always be sold on short notice.
Quick Ratio = (Current Assets – Inventory) / Current Liabilities
Debt-to-Equity Ratio – Measures how much debt the company carries (at a percentage interest rate) vs. the amount of shareholder equity available to cover the debt.
Debt-to-Equity Ratio = Total Debt / Total Shareholder Equity
Average Collection Period – Many companies provide their goods and services on credit and bill their customers for the amount, expecting payment within a specified time period as agreed to with the client, for example, 30 days or 45 days. The average collection period represents the time it takes for a business to collect payment for its outstanding account receivables (AR). AR is considered a short-term asset that can be converted quickly into cash. The lower the average collection period, the faster the company is being paid. When a company experiences a cash flow problem, the average collection period (and similar KPIs) will show whether it is taking too long for its clients to pay them. The average collection period is calculated by dividing the average AR balance by the net credit sales for a specific period (typically a year).
Average Collection Period = (Average AR / Net Credit Sales) * 365 days
Return on Equity – Measures the rate of return the company earns by leveraging the equity investments of its shareholders to produce profit by dividing the net profit by the shareholder equity.
Return on Equity = 100% * (Net Income / Shareholder Equity)
Throughput – A fundamental measurement in manufacturing. Throughput measures the production capabilities of a machine or factory over a specified time period.
Throughput = # of Units Produced / Time
Cycle Time – Measures the amount of time to produce a product. This can look at simply putting components together at the factory, or it could also consider the time it takes to assemble the individual components from remote locations and ship them to the factory to complete the assembly. Cycle Time and Throughput are critical to establish delivery schedules.
Cycle Time = End Time of Manufacture – Start Time of Manufacture
Capacity Utilization – Measures how much of the manufacturing capacity is being utilized. At 100%, the plant is producing as much as it can without expanding the facility.
Capacity Utilization = (Total Produced over a time period / Total Available at capacity) * 100%
Production Costs – Adds all the expenses related to the manufacture of a product, including overhead (power, water, rent, etc.). This number is used to derive the per unit production cost.
Production Costs = Total Direct Labor Cost + Total Direct Material Cost + Overhead Costs
Per-unit product cost = Production cost/number of units manufactured
Schedule Attainment – This percentage measures how well you reached your target production number given a period of time.
Schedule Attainment = 100% * (# of units produced) / (target production output)
Inventory Turnover – Represents the number of times the company was able to sell its entire inventory over the course of the accounting period. The figure will show whether or not the company is keeping excessive inventory.
Inventory Turnover = COGS / Avg inventory balance for the period
Stockout Rate – Is a percentage representing the number of times inventory was out of stock when a customer was ready to buy. A high Stockout Rate indicates poor inventory management, resulting in lost sales and low customer satisfaction.
Inventory Carrying Cost – Represents the cost of holding inventory and includes storage, heating/cooling, property rent, insurance, and other expenses. Carrying costs accrue the longer items remain in inventory.
Lead time – Measures the time required before inventory can be replenished after being sold. Longer lead times require that more items be held in inventory to avoid stockouts.
Customer related KPIs
These KPIs measure how loyal customers are to the company, how much it should invest in its marketing efforts, and how well it retains its customers.
Customer Lifetime Value – Loyal customers add value to your company. Not only do they return to purchase more goods and services, but they also spread your name via word of mouth. The customer lifetime value metric measures the value a customer represents to the company over their lifetime.
Customer Acquisition Cost – This metric calculates how much marketing spend (advertising, incentives, discounts, etc.) the company spends, on average, to acquire a customer.
Customer Churn – Represents the percentage of customers a business lost over a period of time (for example, 90 days).
There are many other KPIs for manufacturing, distributors, retailers, and other industries. The KPIs shown here can help management identify the KPIs they should be monitoring and the values they should have as their goal.
Talk to ArcherPoint to learn more about how you can gain greater insights into your company’s health.