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Beyond the balance sheet

How to develop important key performance indicators to grow your business

Ercan Demiralay 28/7/2022 14 minute read

Ercan Demiralay FCCA, explains the importance of key performance indicators to help you grow your business.

How do you know how well your business is doing?

Ultimately the answer to this question comes down to measurement. You may have reports on performance in various areas of your business, but are you measuring that against other things? If not, how will you know if you're on track, or falling short?

This is where Key Performance Indicators (KPIs) come in as they help you to both measure and improve your business as opposed to just reviewing various different data. The question then is which KPIs should you focus on? 

There aren't any specific, hard rules as to which KPIs you should track, it depends on the nature of your organisation, and your circumstances. In this blog post we'll look at the common KPIs you may want to track, when to apply them, and what to consider.

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What are KPI's?

KPI's are measurable statistics that reflect how well your business is doing and how close you are to reaching your objectives. Keeping a good eye on KPIs will help you make decisions with your business and determine whether your strategies and investments are paying off. 

KPI's aren't to be confused with goals or objectives. A goal is an outcome that you hope to achieve, usually in a set timeframe. The KPI on the other hand is a metric that you use to determine how well you're progressing towards that goal. It's the measure you use to help you decipher if your results will allow you to attain your goal(s).

Your KPI's will therefore be determined by the type of business you have, as well as your strategy and goals. They help you understand what is, and isn't, working effectively in your business. You can then make any necessary adjustments, or not, as the case may be.

How to choose the right KPI's for your business?

There is no unique set of KPI's that every business should measure because what you should track is dependent on what stage your business is at in the lifecycle stages, and the objectives you have set, either from the outset or your current stage of development.

There are a few KPI's that every business should consider monitoring because there is by nature certain items that may be universally important regardless of size, sector or demographic. Furthermore, as a business owner, depending on the sort of business you operate, there is likely to be a lengthy list of other indicators that may be relevant and worth considering.

You cannot possibly track every KPI for a small business due to the limitations of time, effort, and resources. That would not only be challenging, but it could also cause you to lose sight of what is truly essential. There are three factors that you should carefully consider when choosing your KPIs. The three factors to decide KPIs for your business are:

Plan your business objectives

Business owners often focus their attention on what the bottom line can be for their business. While it is important to keep track of whether your business is becoming more or less profitable, this is not the only factor you should keep track of. Good KPI's will assist you in determining what is most important to your business.

Think about all the different goals that you have set, you might have objectives for your consumers or clients, your people, your operations, and your sales and marketing. What are the most essential measures in relation to those goals?

For example, customer satisfaction and lifetime value of a customer may be extremely significant for some businesses. Performance for other businesses may be determined by staff productivity or the speed in which they sell their merchandise. KPI's will be more helpful if you choose them based on the goals you have specifically set.

Consider which stage you're at

At various stages of your business lifecycle, certain KPI's will be more significant than others.  A start-up may be trying to establish and stabilise cash flow, this might then place emphasis on a metric such as the days sales outstanding (DSO). The reason being it measures how quickly it can turn a receivable (the balance of money owed for goods or services) into cash.

DSO may be less important to an established business, where working capital is not so tight and its credit terms with customers may be longer. Instead, at this stage you may concentrate more on staff retention, for example, to help you expand the business. You should therefore focus on the most relevant KPI's that best lend themselves to where you are, and where you're looking to get to, on your journey.

Include both lagging and leading indicators

Choosing both lagging and leading indicators is the optimal KPI combination. What do these means? A leading indicator is the one that looks ahead and has the ability to affect outcomes. A lagging indicator, on the other hand, is backward-looking and will tell you the results that have already happened.

For example, customer satisfaction is considered as a leading indicator. If your services and products provide a remarkable experience for your customers, they are likely to return. As a result, the sales for your business will start to grow at an exponential rate, which is considered healthy.  

Profit on the other hand, is a lagging indicator. It is useful in demonstrating how well your business has performed in the past but does not necessarily provide much insight into future performance.

 

5 KPIs you should track:

There are a handful of KPI's that practically every business owner should consider monitoring. These are essential to understanding the health of your organisation. These aren't necessarily the only ones you will want to measure but they're a good starting point.

 

1. Net profit:

Tracking your net profit over time is a simple and easy place to start with. Is your business becoming more profitable, or less profitable, over time?

Blog - Net ProfitYou cannot always count on net profit to rise immediately. When you invest in your business, or when the economy is struggling, your profits can take a hit.  Keeping a track of them is a crucial measure every owner manager needs to be aware of to ensure you have the means to keep trading.

2. Net profit margin

Your Net profit margin, is a metric for determining how profitable your business is as a percentage of your turnover.  It will show you how well your revenue is being utilised, similar to the net profit statistic and the higher the figure the healthier you can consider the business to be.

Bog - Net Profit Margin KPIYour profit margin is 40% if your business generates £100,000 in revenue and makes a net profit of £40,000 over the year.

This indicates that, your business keeps £0.40 for every pound you make. When you compare your profit margin for year to year, you can evaluate if a rise in sales leads to a similar gain in profits. 

3. The Quick Ratio

Business owners need to keep a close eye on their cash flow as it is frequently recognised as one of the leading causes of small business failure, namely they run out of cash.

The quick ratio is a metric that shows if your cash, assets and receivables are sufficient to pay your liabilities. The formula is as follows:

Blog - Quick Ratio KPIIf you have £10,000 in cash, £5,000 in accounts receivable, and £12,000 in current payables, your calculation will be (£10,000 + £5,000) / £12,000 = 1.25

If your quick ratio is 1 or greater, you have sufficient funds and liquid assets (assets that can be sold quickly for cash) to pay down your debts. A quick ratio of less than one indicates that covering immediate responsibilities may be more difficult.

4. Customer acquisition cost

Do you know how much it costs your business to acquire a new customer (or client)? You might not be concerned about how much it costs to make a sale in the early stages of your business but when you expand, this can be a vital indicator to monitor.

How much it costs to get a single customer? Use the following equation:

Blog - Customer Acquisition Cost KPISo, if you spent £5,000 on marketing over a quarter and acquired 10 new clients, your customer (or client) acquisition cost per client is £500.

5. Lifetime value of a customer

What is the value of a customer to your business over time? This is a crucial number to understand since it may assist you in determining how much you can spend on sales and marketing. If you know your average client spends £100 with you, you'll want to make sure your acquisition expenses are far lower.

This is more difficult to measure than some other KPI's. As a result, some businesses will be able to measure it more easily than others.

If you work with clients on a retainer model, it is relatively easy to measure:

Blog - Lifetime value of customer KPIYou'll need to perform a bit more research if you work with clients on a project basis. You may calculate the average lifetime value of a customer by estimating the average number of projects you undertake with a client and the average cost of each project:Blog - Lifetime value of client KPI

Other KPI's to consider tracking:

The KPI's listed above aren't the only ones to keep an eye on. Others, depending on the type and stage of your business, can provide you with an accurate picture of how effectively you're functioning:

1. Conversion Rate

This basic statistic defines how many leads turn into customers. Depending on the sort of business you run, you may assess conversion rate in a variety of ways.

You may determine this for an online business by comparing the number of customers who made a purchase last month to the number of people who visited your site. Let's pretend you have 400 sales and 10,000 unique visits in a month. The conversion rate for you would be 4%.

Alternatively, an agency's conversion rate would be 20% if they pitch 10 new customers in a month, and secure two of the projects.

Tracking your conversion rate over time will allow you to evaluate if the sales and marketing investments you make are leading to more business.

2. Gross Profit Margin

If your business sells commodities, one KPI to track is the gross profit margin. After paying for the items you sell, your gross profit margin ratio will inform you how much money is left over.

The gross profit margin ratio can be calculated on a product-by-product basis or as a whole for your business.

Let's imagine you sell £10,000 in a month and your cost of goods sold (COGS) is £4,000. The gross profit margin is 60% as a percentage. It's calculated as follows:

Blog - Gross Profit Margin KPIIt's computed by dividing your gross margin (10,000 sales minus £4,000 in COGS) by total sales.

You can perform the same calculation on each item if you want to discover which commodities are the most profitable for you to sell. Let's say you're selling shirts and a consumer pays £20 for one. If the shirt costs you £8, your gross margin ratio on the item is 60%. (£20 – £8) / £20) = 60%

The bigger your gross profit margin, the more money you'll have left over to cover other costs like staff, rent, and marketing as well as potentially some left over as net profit.

3. Monthly Recurring Revenue

Many of your clients on retainer may be a source of monthly recurring revenue for some service-based enterprises. If you have two £1,000 per month recurring client contracts, your monthly recurring revenue is £2,000 per month.

This can assist in planning. As a consequence, you'll have a good idea of what your monthly minimum revenue will be, and you can budget any expenditure accordingly.

4. Day sales outstanding (DSO)

When it comes to getting paid, how efficient is your business? This is critical for every business. However, for new businesses or those attempting to stabilise their cash flow, this is particularly important.

DSO is a metric for determining how long a receivable has been outstanding. For instance, how long does it take on average for your organisation to receive the cash once a transaction is made?

Blog - Day Sales Outstanding KPIDSO is calculated by multiplying the total sales by the number of days in a period and dividing the accounts receivable balance by the total sales. Let's imagine you had £50,000 in credit sales in January (sales where the consumer didn't pay right away). With 31 days left in the month and a £30,000 accounts receivable amount, your DSO is 18.6.

When your DSO rises or your business is experiencing delays in receiving payments which will cause a cash flow problem, it may be time to work on optimising your receivables process. 

When your business is experiencing delays in receiving payments, it can cause a cash flow problem. This means your DSO will rise and it may be to work on optimising your receivables process. A low DSO usually indicates that your business is getting its payments quickly or on time.

5. Website traffic

Understanding how much traffic your webpage generates is one of your essential KPI's if you operate an e-commerce business. There isn't any math involved here. Instead, you'll measure traffic trends over time using a tool such as Google Analytics.

Analysing your traffic may help you figure out why, and when, traffic spikes and dips occur. You'll also gain a deeper understanding of your visitors. Does running an ad campaign result in an increase in traffic? Is there a greater increase in traffic when you have a sale? Is your traffic steadily increasing (a positive indicator) or steadily decreasing?

This usually dovetails nicely with the conversion rate metric mentioned above and in conjunction with the top and bottom line in your business.

Setting up your KPI's for small business tracking

Once you’ve decided on the right KPI's to track for your business, you’ll want to set up your KPI tracking the right way.

1. Utilise tools to track performance

There will be a lot of things to keep in mind as a business owner. Adding several KPI's to your list of things to track without creating an easy way to do so can lead to unwanted chaos in your business and workload.

Thankfully, there are a variety of tools available to assist you in gathering the data you need to track those essential metrics.  As a result, you'll spend less time tinkering with spreadsheets and more time focusing on your business.

2. Cloud accounting software

            Cloud accounting software allows you to keep track of your essential financial figures in, more or less, real time. It may be possible to create a dashboard that displays your most essential stats once you've logged in. 

3. Align Stakeholders

It's critical that every stakeholder in your business understands the KPI's to track and agrees that they're significant.  Each person's priorities may alter depending on their position. There may therefore be ones they are responsible for or more interested in. The Finance Director might focus more on the financial metrics whereas the Marketing Director may focus more on the website and lead generation side of the business.

Regardless of size, industry and the complexity of your business, the people at the helm should consider, evaluate, and constantly review the most relevant and significant metrics for the business.  These should become the core of their focus and committing to improve them over time is likely to lead to prosperity for themselves, employees, and stakeholders.

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The content of this post was created on 06/07/2022, and was updated on 28/07/2022.
Please be aware that information provided by this blog is subject to regular legal and regulatory change. We recommend that you do not take any information held within our website or guides (eBooks) as a definitive guide to the law on the relevant matter being discussed. We suggest your course of action should be to seek legal or professional advice where necessary rather than relying on the content supplied by the author(s) of this blog.

 

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