5 Essential Financial KPIs Every Finance Leader Should Track
Financial Planning and Analysis (FP&A) plays a crucial role in driving the financial health and success of an organization. To effectively manage and guide their company’s financial strategy, finance leaders must have a comprehensive understanding of key performance indicators (KPIs). These KPIs provide valuable insights into an organization’s financial performance, helping finance leaders make informed decisions and drive growth.
In this article, we will explore five essential financial KPIs that every finance leader should track, highlighting their significance and how they contribute to financial success.
- Revenue growth is a fundamental KPI that indicates the overall health of an organization’s top line.
- By tracking revenue growth, Finance leaders can evaluate the effectiveness of their sales and marketing strategies, identify areas for improvement, and make informed decisions regarding future investments and resource allocation.
- Example: Let’s say a company had revenue of $1 million in the previous year and $1.5 million in the current year. The revenue growth can be calculated as ($1.5 million - $1 million) / $1 million * 100 = 50%.
- Measuring Business Performance: Revenue growth indicates the success of the company’s sales and marketing efforts. Positive revenue growth signifies increasing market demand, effective customer acquisition strategies, and successful product launches.
- Revenue is driven by two key components; the unit price of the product/service and number of units sold. The dynamics of both should be covered in your KPIs
Here is a great resource to guide your contribution to growing revenue, CFO Talk: The CFO as a Key Player in Pricing. In this video Mark Stiving, founder of Impact Pricing, helps CFOs understand how to play a key and value-added role in the pricing of products and services for their companies.
- Gross margin is a critical KPI that measures the profitability of an organization’s core operations.
- By monitoring gross margin, Finance leaders can assess the efficiency of production processes, pricing strategies, and cost management, enabling them to make data-driven decisions to improve profitability and maintain a competitive edge.
- Example: Suppose a company had total sales of $500,000 and the cost of goods sold (COGS) amounted to $300,000. Gross margin can be calculated as ($500,000 - $300,000) / $500,000 * 100 = 40%.
- Measuring Business Performance: Gross margin measures the profitability of a company’s core operations. A higher gross margin indicates efficient production processes, effective pricing strategies, and better cost management.
Analyzing, understanding and acting on the relationships that make up your gross margin is a critical step in improving it. Use the Simple Price, Gross Margin and Unit Variance Analysis as a key tool in this process.
Operating Expenses Ratio
- The operating expenses ratio provides insights into the efficiency and effectiveness of an organization’s cost management.
- By closely monitoring this KPI, Finance leaders can identify areas of potential cost reduction, optimize resource allocation, and enhance operational efficiency, ultimately improving the company’s bottom line.
- Example: Consider a company with operating expenses (excluding COGS) of $200,000 and revenue of $800,000. The operating expenses ratio can be calculated as $200,000 / $800,000 * 100 = 25%.
- Measuring Business Performance: The operating expenses ratio reflects the efficiency of cost management. A lower ratio indicates effective resource allocation, streamlined operations, and better profitability.
Cost effectiveness is a mindset. This CFO Ed Talk, Andrea Jones helps mold the right mindset in her CFO Ed TalkTM Stop Using Lean to Cut Costs.
Cash Conversion Cycle:
- The cash conversion cycle measures the time it takes for a company to convert its investments in inventory and other resources into cash flow from sales.
- Finance leaders can use this KPI to evaluate the effectiveness of working capital management, optimize cash flow, and identify potential liquidity issues, ensuring the financial stability and sustainability of the organization.
- How do you calculate the cash conversion cycle?
Cash Conversion Cycle = DIO + DSO – DPO
Cash Conversion Cycle-Credit to CFI
Where: DIO stands for Days Inventory Outstanding. DSO stands for Days Sales Outstanding. DPO stands for Days Payable Outstanding
For example, if it takes your business an average of 14.2 days to turn over inventory (DIO = 14.2), 15.6 days to receive payment from customers (DSO = 15.6), and 17.3 days to pay suppliers (DPO = 17.3), your cash conversion cycle would be 12.5 days (or 14.2+15.6 — 17.3).
- What is a good CCC ratio?
A good cash conversion cycle is a short one. If your CCC is a low or (better yet) a negative number, that means your working capital is not tied up for long, and your business has greater liquidity
Use this tool, the Cash Velocity Calculator, when developing your cash conversion cycle KPIs. It’s also perfect for teaching your executive team and staff about the specific working capital and cash management levers that can improve your CCC.
Return on Investment (ROI)
- ROI is a key financial metric that assesses the profitability of investments made by the organization.
- By tracking ROI, Finance leaders can evaluate the success of various projects and initiatives, make informed investment decisions, and allocate resources to areas that generate the highest returns, ultimately driving long-term growth and maximizing shareholder value.
- Example: Let’s assume a company invested $100,000 in a project, and it generated $30,000 in profits. The ROI can be calculated as ($30,000 / $100,000) * 100 = 30%.
- Measuring Business Performance: ROI evaluates the profitability of investments. A higher ROI indicates successful projects and initiatives, efficient capital allocation, and maximization of shareholder value.
Use the Capital Investment Analysis Request Form for all your large capital investment analysis.
Tracking the right financial KPIs is paramount for Finance leaders to effectively manage an organization’s financial health and drive its success. By monitoring revenue growth, gross margin, operating expenses ratio, cash conversion cycle, and return on investment, Finance leaders can gain valuable insights into their company’s financial performance, make informed decisions, and contribute to sustainable growth.
These essential KPIs provide a holistic view of the organization’s financial landscape, enabling Finance leaders to identify areas for improvement, allocate resources effectively, and navigate financial challenges with confidence.
By leveraging these KPIs, Finance leaders can strengthen their financial strategies, optimize profitability, and ensure the long-term success of their organization.
For instructions on how to develop the right KPIs for your business visit Bernie Smith’s library.
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