31 Oct., 2019
Measuring Key Performance Indicators (KPIs) is critical for the management of small businesses to understand their overall health and how realistic their company goals are.
Whilst every small business is unique, based on their location, sector and size, there is a common set of financial KPIs small businesses can use to regularly assess and better understand both the long and short term prospects of a company.
Monitoring these will allow employees and internal stakeholders to generate feedback on their efforts.
This will allow them to see whether they are on track to hit targets, or whether a different strategy, such as hiring new staff or putting a greater emphasis on debt chasing, should be applied. Here are the five essential KPIs every small business should consider including in their management packs.
Gross profit: Revenue - cost of sales
Gross profit percentage: Revenue - cost of sales / sales x 100
Gross profit margin, usually expressed as a percentage, allows companies to see the profit they are generating after deducting their costs of sales from their revenues.
Cost of sales are expenses directly related to sales output activity, as opposed to ongoing costs such as rent, heating and lighting. For example, a business manufacturing physical goods will include their cost of materials, staff labour costs in putting goods together and expenses related to getting the items into a sellable condition (i.e. packaging and transportation costs).
Gross profit can be calculated on a value basis or as a percentage of revenues. Gross profit percentage should be relatively constant, as whilst sales volumes can vary the associated margin should be similar.
The value of gross profit indicates excess funds that can be used to budget for general expenses and business expansion.
Receivables days: (Accounts receivable / annual revenue) x 365
Receivables days is one of the best indicators of liquidity (a reflection of how easily assets can be converted into cash) in a business.
Expressed in days, it signals how long it takes to get paid for goods sold on credit. Whilst average receivables days can differ on a sector-specific basis, this KPI illustrates how effective companies are at collecting cash when invoices become due.
Target receivables days should be similar to invoice terms (i.e. 30 days) and an increase suggests that companies are struggling to collect cash promptly.
Receivables days should be measured monthly and are calculated by taking the accounts receivable value from the balance sheet, dividing this by annual revenues and then multiplying it by the number of days in the year.
Inventory turnover: Cost of sales / Stock held
Businesses must ensure that they do not retain stock for too long. Holding on to stock for an increased time can mean that funds are tied up in the business that could be better utilised elsewhere. Additionally, holding on to inventory lines longer than necessary creates the risk that demand for them could fall and result in them having to be sold for a lower price.
It is considered efficient for a business to be turning stock over quickly, so a high stock turnover ratio indicates that the company is not holding on to lines of quantities for longer than needed.
Valid reasons for the monthly inventory turnover ratio flexing during the year can be due to seasonality (creating the necessity to hold more stock on hand for increased demand) or the need to reduce prices of obsolete stock (resulting in a faster turnover of goods) during a sale.
Payroll as a percentage of revenue
Payroll as a percentage of revenue: Salaries / revenues x 100
Payroll is typically one of the highest ongoing costs within a business.
In a company making steady sales the value of payroll should be relatively constant, whereas in a growing business it would be expected for this to increase as new employees are hired to meet increased demand.
In labour intensive businesses such as retail and hospitality, this can be as high as 40%, whereas this can be as low as 10%-20% in sectors that make effective use of automation.
Whilst it can be tricky balancing hiring new employees and ensuring that they are sufficiently utilised, the payroll as a percentage of revenue value should remain unchanged.
Cash flow KPIs
Cash is the lifeblood of businesses. The inability to manage this effectively is one of the most common reasons for businesses failing. It is important to pay attention to cash flow KPIs as even profitable businesses can become unstuck if they fail to monitor their cash flow.
Cash flow KPIs take into account the inflows and outflow of cash over a period of time. Most businesses will measure cash flow monthly but those who are particularly sensitive to movements may review this on a weekly or sometimes even daily basis.
There are several different cash flow KPIs (i.e. cash flow margin, operating and cash flow, free cash flow) but net cash flow and cash on hand are perhaps the most useful.
Net cash flow measures the incremental difference between all inflows and outflows within a set period of time. Correspondingly, this movement will affect cash on hand, which is how much money businesses have on deposit at any one time. These two KPIs can be used in parallel to give insight into how soon businesses are likely to run out of money in the near future.
Putting in place a set of KPIs allows businesses to see how they are functioning, providing them with a high-level overview to see whether their performance is in line with expectations.
This process can be made even easier by using Fathom, which is designed to set up and automate the measurement of KPIs to give businesses detailed insights.
Take a look at our detailed Guide to selecting KPIs for small business to get an in-depth overview and list of KPIs that should be tracked at any lifecycle stage.
Written by Nick Levine
Nick Levine is a chartered accountant and journalist, with a particular interest in fintech. He was formerly the Advisory Lead at Deloitte’s Propel, and the Head of Enterprise for ICAEW. His writing portfolio includes The Times, Wired and Real Business.