KPIs: The Best Christmas Present for Your Business
A KPI is one of those three letter acronyms that pack a punch. Key Performance Indicators (KPIs) are used by accountants to help business owners understand the financial health of their business.
By understanding KPIs in your business, you can track any amount of metrics including your spending and buying patterns, stock control, how quickly (or slowly) you are getting paid. They are a great way to stop assumptions being made. Decisions become informed as they are based on facts and figures and real data.
As a KPI is in reality a metric, then there are some characteristics that you ought to consider before deciding on the important ones.
- They should be relevant
Use metrics that have the most impact on your business. Don’t measure items that you know you’re consistently good at as that will give a false representation of your business.
- They should be in context
When looking at metrics, they should be read in context of your business. If you are a seasonal business, then naturally sales will dip in seasons so that should be taken into account. Profitability, stock control and maybe debtor days will be impacted too.
- Long and short term
Your metrics should be balanced for both long and short term. Cash flow is a good metric for short term and also your ability to pay down debt for the long term.
How Accounting Software Can Help
Most cloud-based or desktop accounting software packages allow you to see in an instant or with a few clicks, reports on how you are performing. While our preferred package is Sage, there are a variety of other providers who show you similar detail on a dashboard or home page. From there, you can easily see some key data.
While many clients are afraid to tell us that they are using accounting software packages, we actively encourage it. It doesn’t replace the accountant, it just makes working with one much easier.
So let’s look at some important KPIs that you should be looking at.
Gross Profit Margin
This is one that tells you whether you are pricing your goods or services correctly. Margin should be enough to cover fixed expenses, in particular, your costs associated with making the product or delivering the service.
Gross profit margin: Total Sales – Cost of Goods Sold divided by Total Sales
Net Profit Margin
This is the grand-daddy of all metrics. It is key to understand this one. It’s the amount of money that you have after paying all your bills.
Net profit margin: net profit divided by total revenue.
Current Ratio
Another really good metric to measure is the ability of your organisation to pay your debts over a given period of time.
This is useful when planing any growth in your business – whether it’s expansion or simply buying extra stock.
Current ratio: current assets divided by current liabilities.
The resulting number should ideally fall between 1.5 and 3. Below 1 means you don’t have enough cash to pay your debts.
Accounts Receivable Turnover
This is a KPI that many clients don’t measure and it’s key, especially for monitoring cash flow. It measures the rate at which you collect on your outstanding accounts.
You may think that you give 30 days credit so all bills are paid within 30 days, give or take 5 days. But digging deeper, you could find that some customers pay you within 10 days, others within 90 days. Knowledge allows you manage the collection and your cashflow.
Accounts Payable Turnover
It also helps you to manage another metric – accounts payable turnover. How quickly do you pay your bills? Are you as quick to pay as you think you are?
To summarise, use your KPIs with common sense in mind. Understanding them is the best Christmas present you can give your business.
AG Associates is an accounting practice that specialises in affordable accounting and payroll solutions for the SME business owner. It also offers training on accounting software. For further information please contact Angela at Unit 11, Eastgate Way, Little Island, Cork. 021 4824723 or angela@agassociates.ie