Eight financial KPIs to help

measure your business’s

performance
1. Gross profit margin
2. Net profit
3. Net profit margin
4. Aging accounts receivable
5. Current ratio
6. Quick ratio
7. Customer acquisition ratio
8. Return on investment for research and Development

When running a small business, you can’t rely on your gut instinct all the time, especially
when it comes to evaluating your company’s financial health. You should be objective rather
than subjective when determining the financial health of your company.
One way to objectively track the health of your business is through the use of key
performance indicators, otherwise known as KPIs. Different types of KPIs represent an array
of markers that companies use to measure performance in a variety of areas — from
marketing campaigns to supply chain management to finance.

According to KPI.org, KPIs “are the critical (key) indicators of progress toward an intended
result. KPIs provide a focus for strategic and operational improvement, create an analytics
basis for decision-making, and help focus attention on what matters most.”
Keeping close tabs on your small business’s financial performance is essential to long-term
success. Below, you’ll find eight actionable KPIs that will help you measure your business’s
financial health.

1. Gross profit margin

Your gross profit margin provides you with a percentage, indicating how much of your
revenue is profit after factoring in expenses like the cost of production and sales. The formula
to calculate gross profit margin is:

Gross profit margin = (revenue – costs of goods sold) ÷ revenue

Costs of Goods Sold are all the direct expenses associated with the product. It does not
include things like interest payments, taxes, or operating expenses.

So for instance, imagine that you earn $1 million in total revenue for the year. The direct
costs associated with your product are $400,000. The equation would then look like this:

Gross profit margin = ($1,000,000 – $400,000) ÷ $1,000,000 = 60%

Your gross profit margin should be large enough to cover your fixed (operating) expenses
and leave you with a profit at the end of the day. You can then use the extra earnings for
things like marketing campaigns, dividend payouts, and other non-fixed costs.

Typically, you want your gross profit margin to be at least 10%. Anything lower than that
may be cause for concern. Gross profit margins can also vary considerably by industry. For
instance, engineering and construction firms have an average gross profit margin of 12.15%.
Banks, on the other hand, have 100% profit margins. So long as you’re hitting or exceeding
your industry average, you’re in good shape.

2. Net profit
Your net profit is your bottom line — the amount of cash left over after you’ve paid all the
bills. Net profit accounts for both direct and indirect expenses. The formula for calculating
net profit is straightforward.

Net profit = total revenue – total expenses

For example, if your sales last year totaled $100,000 and your business expenses for rent,
inventory, salaries, etc. added up to $80,000, your net profit is $20,000.
There is no exact amount that specifies what a “healthy” net profit is. However, as a rule of
thumb, you’ll want to make sure that you have a net profit instead of a net loss.

3. Net profit margin

Net profit margin tells you what percentage of your revenue was profit. However, unlike the
gross profit margin, it accounts for all expenses, not just direct costs.

Net profit margin = (total revenue – total expenses) ÷ total revenue

In the example above, let’s say that you earn $1 million in revenue. However, after
accounting for non-operating expenses, your total expenses are $950,000. You determine
that:

Net profit margin = ($1,000,000 – $950,000) ÷ $1,000,000 = 5%

This metric helps you project future profits and set goals and benchmarks for profitability.
After comparing this to the gross profit margin in the previous example, you feel as though
your net profit margin is too low. You know that the fundamental change between the two
formulas was the addition of non-operating expenses. You may want to consider cutting back
on non-essential costs to improve your net profit margin.

Like with gross margins, net margins also vary by industry. It’s also reasonable to expect net
margins to be considerably lower than gross margins. For instance, the average gross margin
for the advertising industry is 28.54%, but the average net margin is only 3.10%.

4. Aging accounts receivable

If your business involves sending bills to customers, an accounts receivable aging report can
be eye-opening. This KPI is not so much a metric with an equation. Instead, it’s a report that
lists unused credit memos and unpaid customer invoices. This report can be particularly
useful for those with cash flow problems, as it can identify the root cause of the problem.

If customer A consistently pays her bills within 15 days, while customers B, C, and D drag
their payments out to 90 or even 120 days, you may have found a root cause of your
business’s cash flow problems. You can then take steps to start charging interest on overdue
accounts or let go of slow-paying clients.

5. Current ratio
Current ratio provides you with a measure of liquidity. You can use this KPI to determine if
you have the necessary cash on hand to fund a large purchase. Creditors may also use this
formula to determine the likelihood of you repaying a loan.

Current ratio = current assets ÷ current liabilities

Current assets are things like cash and other assets that you expect to be converted to cash
within one year. Current liabilities are debts that you expect to repay within a year.
The resulting number should ideally fall between 1.5% and 3%. A current ratio of less than
1% is significantly concerning, as it means you don’t have enough cash coming in to pay
your bills. Tracking this indicator may give you a warning of cash flow problems.

6. Quick ratio
The quick ratio is another KPI that’s extremely relevant to a business’s financial health. The
quick ratio shows a company’s ability to pay short-term financial liabilities immediately. The
quick ratio is a better indicator of the ability to do so than the current ratio, as the current ratio
accounts for a business’s likelihood of making these payments within a year. The formula for
quick ratio is:

Quick ratio = (current assets – inventories) ÷ current liabilities

You may also see people refer to this KPI as the “Acid Test Ratio.” That’s because acid tests
are designed to produce quick results, much like this ratio. Essentially, this KPI is a measure
of a company’s immediate liquidity and cash on hand.

7. Customer acquisition ratio

Another way to measure financial health is to compare how much revenue you receive per
new customer. This KPI is easy to set up.

Customer acquisition ratio = net expected lifetime profit from customer ÷ cost to
acquire customer
To calculate the expected lifetime profit from the customer, you’ll need to consider a
customer’s purchasing frequency and average purchasing price. Your costs to acquire the
customer can include things like marketing and onboarding costs. The actual variables that
make up these components will vary from company to company.

If your firm is healthy, this ratio will be at least one. If it’s less than one, it’s an indication
that you’re spending too much to acquire customers and losing money as a result. A high
ratio, on the other hand, means that your investment is worthwhile. For instance, imagine the
equation yields a customer acquisition ratio of three. This means that you’re earning $3 for
every $1 you spend to acquire a new customer.

8. Return on investment for research and

development
Another key metric that you can consider is return on investment (ROI) for research and
development. This can include a broad range of expenses. For instance, let’s say that you’re
focused on customer outreach and want to see if your research efforts are worthwhile. You’d
be able to make that determination with this KPI.

ROI of research and development = (Gain from investment – cost of investment) ÷ cost
of investment
 There’s no black and white answer as to what a good ROI is. If you’re in the 5% range, you
should be comfortable that your efforts are paying off. Anything lower than that and you may
want to evaluate whether you should reallocate your R&D funds.

Which KPIs are best?

The eight KPIs above can go a long way toward helping you track your company’s financial
health. A good KPI is one that is measurable and that relates directly to your strategic goals.
However, not all KPIs are necessarily the same. The needs of one business might vary from
those of another. For instance, a brick-and-mortar store may not focus as much on customer
acquisitions or website traffic, just like an e-commerce company wouldn’t concentrate on
sales per square foot.
You’ll want to consider where your company is in the business process when choosing KPIs.
For instance, if you don’t have a deliverable product yet, you don’t need to worry about KPIs
like cost per acquisition, number of customers acquired, or lifetime value. Focusing on
relevant KPIs will help streamline the decision-making process.

Lastly, you’ll want to make sure that your performance measurement includes both leading
indicators and lagging indicators. Lagging indicators involve things that have already
happened in the past. KPI examples of lagging indicators include total sales last month and
income per employee. Leading indicators, on the other hand, are important metrics that keep
track of inputs, allowing you to determine how likely you are to meet your strategic goals.
Conversion rates are an excellent example of a leading indicator.

Start defining KPIs for your business

When determining which are the right KPIs for your business, you should ask yourself a few
questions:

 What is the ultimate goal that you’re looking to achieve?

 Why is this goal relevant?
 What objective information can you use to define progress and success (or failure)?
 What variables will influence the outcome of this goal?
 When will you know that you’ve achieved your goal?
 What time frame would you like to use for measuring your goal?
For instance, imagine you notice that your revenues are down for the year. You want to track
sales KPIs to help improve your annual income. You decide to add “Sales Growth” to your
KPI dashboard. Your goal is to increase revenue by 10% over the next six months, a relevant
goal because it will allow your company to become more profitable

You determine that you can measure your progress toward this goal by tracking an increase
in revenue versus an increase in dollars spent. You then realize that hiring additional sales
staff and focusing on customer satisfaction and retention can help you achieve these goals.
 You’ll know after six months whether you’ve completed this goal, although you’ll check in
every four weeks for a real-time depiction of how you’re doing.

Using these criteria ensures that you’re creating SMARTER KPIs. SMARTER stands for:

 Specific
 Measurable
 Attainable
 Relevant
 Time-Frame
 Evaluate
 Re-evaluate
Choosing SMARTER KPIs ensures that these key metrics are working well for you,
increasing your chances of meeting your short-term and long-term goals.