13 Financial Metrics to Track (And Why They're Important)
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If you work in business or finance, understanding what financial metrics are and how to apply them is an important skill. These metrics help business professionals understand the financial health and sustainability of an organisation's operations. Learning about these performance metrics and some common metrics to track can help you apply these performance measurements in the workplace. In this article, we define what financial metrics are, outline the importance of performance metrics for businesses and discuss 13 of the most important metrics for business professionals to track and consider.
What are financial metrics?
Financial metrics, also called financial key performance indicators (KPIs), are data points that business leaders and finance professionals monitor to assess the financial health of a business. Most commonly, these metrics include categories such as profitability, liquidity, solvency, efficiency and valuation. When you track and analyse these metrics, it can help the leaders of a company make effective business decisions.
Monitoring metrics allows you to see the organisation's successes, growth opportunities and areas for improvement. Identifying and targeting these areas with strategic business plans can lead to performance growth and success to reach financial goals and improve the company's profitability.
Why are financial metrics important?
Companies rely on data to understand how their business plans and operations translate into financial viability. This means that companies track data related to their financial health so they can make important decisions to improve their budgetary functioning and increase their profitability. Tracking metrics helps professionals gain insight into the effectiveness of their current strategies so they can identify growth opportunities. When business executives use data to understand the cause-and-effect relationships between their business strategies and their profitability, it can support them in making effective decisions about the future of their businesses.
13 financial performance metrics to measure
Here are 13 of the most common and important financial performance metrics for businesses to monitor:
1. Gross profit margin
Gross profit margin is an essential ratio that helps you assess the profit earned from sales after subtracting the cost of goods sold. In this case, the cost of goods sold includes all production costs incurred, such as the cost of materials, transportation and storage, but excludes operating expenses, interest and taxes.
This is a measurement of the company's profitability. When you understand how much revenue you generate in comparison to the cost of producing goods for customers, you can identify what proportion of profit the company is making from sales. Increasing revenue while decreasing expenses improves the gross profit margin.
2. Net profit margin
Net profit margin is similar to gross profit margin. It's also a measure of a company's profitability. This metric differs from gross profit margin because it includes all business expenses. In addition to accounting for the cost of goods sold, net profit margin also considers operation expenses, interest, taxes and other essential operational costs. Compared to gross profit margin, the net profit margin offers a more comprehensive ratio of revenue to costs. This metric helps business executives understand their profitability based on a holistic representation of the costs incurred through their business operations.
3. Working capital
Businesses calculate their working capital to understand their available operating liquidity. These are the funds that a business can access to manage its daily operations. Liquidity refers to a company's available funds that they can access quickly and easily to apply to day-to-day operating expenses. A business needs some liquidity so that they have access to funds as needed to make everyday purchases for essentials like office supplies. Calculating working capital helps businesses determine how much capital they can use toward everyday purchases, and they can calculate this metric by subtracting their current liabilities from their current assets.
4. Current ratio
The current ratio is another metric that helps businesses calculate their current liquidity. Unlike working capital, this metric is a measure of the available liquid assets that a business can apply to its short-term obligations. While working capital measures a company's access to immediate funds to cover immediate costs, the current ratio assesses the company's liquidity for covering short-term costs. Shot-term costs refer to any financial obligations due within a year. For example, if a company expands their operations and needs to pay back a loan over the following year, this metric can help it determine its liquidity for payment.
5. Quick ratio
Another type of liquidity metric is the quick ratio, also called the acid test ratio. This metric is similar to the current ratio because it also assesses the liquidity of assets for meeting short-term financial obligations. The difference between the quick ratio and the current ratio is the quick ratio only accounts for the most liquid assets. These assets include cash, marketable securities and accounts receivable because these are the assets that companies can convert into available funds most readily.
Leverage, also called the equity multiplier, is the use of debts to purchase assets. Business leaders can use this metric to assess the risk to their business. For example, when a company finances its assets by equity, then the multiplier is one. When debt increases, so does the multiplier. This demonstrates the leverage impact of debt and reflects the increased risk to a business. You can calculate leverage by dividing the company's total assets by the total equity.
7. Debt-to-equity ratio
The debt-to-equity ratio is a solvency ratio that company leaders can use to measure how much a business finances itself using equity versus debt. Solvency is the degree to which a company's current assets exceed its current liabilities. Having solvency is important for businesses looking to meet their long-term fixed expenses while achieving expansion and growth. By calculating the debt-to-equity ratio, business executives can gain insight into their company's solvency by revealing the ability of shareholder equity to meet debt expenses in case of a business downturn. To calculate this ratio, divide total debt by total equity.
8. Inventory turnover
Companies calculate their inventory turnover to assess how many times they sell their entire inventory per accounting period. This is a useful metric for determining whether the company has the right volume of inventory relative to its sales level. For example, if a business sells its whole inventory several times per accounting period, it may consider expanding its inventory. If it sells out of its inventory relatively infrequently, it may reduce its inventory.
9. Total asset turnover
Related to inventory turnover, the total asset turnover metric measures how efficiently a company uses its assets to generate revenue. Typically, businesses want to achieve a high total asset turnover ratio. When the turnover ratio is high for assets, it indicates business success. To calculate total asset turnover, add the beginning total assets and the ending total assets as divided by two. Then divide the revenue by that number.
10. Return on equity
Return on equity is another profitability ratio. You can find the return on equity by dividing net profit over shareholders' equity. When you have a strong return on equity, it indicates that the business is effectively using equity investments to earn a profit for investors. A business that's profitable for investors is likely to maintain its support and attract additional shareholders.
11. Return on assets
Similar to return on equity, return on assets is a type of profitability ratio. Instead of emphasising how efficiently a company uses equity investments, this is a measure of a company's ability to use its assets optimally. When businesses use their assets and resources effectively, they may have a net gain in earned profits. To calculate this ratio, divide the company's net profit by the average assets.
12. Operating cash flow
Operating cash flow allows businesses to determine how much cash they have as a result of their operations. Cash flow can either be positive or negative. Having a negative cash flow means that the business is spending more than it's earning through its operations, which is often common for new businesses that are working to reach their revenue goals.
A positive cash flow means that the business is earning more than it's spending, which means that it's generating a profit. Calculating cash flow is essential for knowing whether the company is generating profit or if the managers should adjust their strategies to earn more.
You may calculate seasonality to understand how the time of year affects the company's profit. For example, some types of businesses may face more seasonal impacts than others. A clothing retailer may sell more of some types of clothes in the summer months and other types during the winter because demand for these clothing types changes based on the weather. Financial metrics can help you identify, analyse and monitor seasonal buying habits so you can optimise the company's sales during these times.
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