If you’re like me, you’re reflecting on 2015 and setting the table for 2016. What are you going to start doing, stop doing and keep doing? One of the ways of determining this is to look at the key metrics of your business to determine if you’re on the right track for success or what changes need to be made to get back on track. The key metrics that you’re using to make changes can become key performance indicators (KPI’s) that you and your team want to track regularly. Here are the three things you must know about KPI’s.
1. KPI’s build on each other. They are derived from the metrics in your business which are created out of measurements. These measurements can include profitability, revenue, or number of customers. Generally, ratios and percentages make the best KPI’s. So, instead of looking profitability, look at your gross or net profit margin.
2. KPI’s become relevant when they are measured over time. So, looking at your gross or net profit margin this year against the last two years can tell whether you’re improving, declining or inconsistent. The numbers will tell you what’s going on, but more importantly if you can determine the “what” behind the “why”, you can then begin to make changes in your strategy and execution to improve.
3. The KPI’s that a company measures will vary depending on the type of business and industry. However, I’ll share with you a couple of my favorites. I find that most business owners are interested in 4 things: profit, cash, leverage and activity (AR and inventory).
- For profitability, most businesses will track gross margin (gross profit/revenue) and net margin (net profit/revenue).
- For cash, I like days sales in cash (cash/daily sales). Take your annual revenue/360 to come up with your daily sales, then divide that number in to your cash balance at year end.
- For leverage, I like the leverage ratio (debt/net worth). This tells how much of other peoples’ money you’re using in your business vs your own.
- For activity, I like AR turnover (annual revenue/AR balance) and inventory turnover (annual cost of goods sold/inventory balance). This KPI can be expressed in a number or expressed in days. To come up with the days calculation, divide your number into 360. Here’s an example: if your annual revenue is $5 million and your AR balance is $400,000, then your AR turns 12.5 times/year or you have 28.8 days of sales in AR. ($400,000/12.5=28.8 days)
I have a great story from one client of mine. When we started working together their gross profit margin was hovering around 30%, but the owner focused hard on that KPI and over a 5 year period she improved it to over 40%.
KPI’s can be invaluable to help you create the best version of your company possible in this highly competitive environment. I would suggest you establish your own KPI’s (if you haven’t already) and begin tracking your progress.
