Business Financial Metrics vs. Financial KPIs
Many people use the terms “metric” and “KPI” interchangeably, but they’re technically different things.
- Business Financial Metrics: Financial metrics are quantitative measurements used to track the performance of specific financial processes.
- Financial KPIs: Short for “key process indicator,” a KPI is a measure of financial performance or progress based on a business’s goals or objectives. In other words, all KPIs are metrics, but not all metrics are KPIs.
Revenue refers to the total amount of money the business brings in from its products or services.
Monthly Recurring Revenue (MRR)
Businesses that use a subscription-based model should also calculate the monthly recurring revenue (MRR). It refers to the amount of revenue generated from subscriptions. Once a business knows its MRR, it can make an educated guess as to what revenue will look like down the road. This makes it easier to decide when it’s time to make certain investments, such as hiring new employees or purchasing new equipment.
Average Revenue Per Account (ARPA) and Average Revenue Per User (ARPU)
SaaS companies often measure average revenue per account (ARPA) and average revenue per user (ARPU). Both are typically measured on a monthly basis and can help a business make more informed decisions about its growth strategy.
For instance, a CRM company will have businesses as clients, and each business will have its own account. Each account will have a certain number of seats or users. If the CRM company offers two tiers of service – one at $50 per month and one at $100 per month – and its ARPA is $60, stakeholders know that accounts gravitate toward the less expensive tier. From there, they can decide whether the better strategy is to try to attract more new customers to the premium tier, invest in marketing to upsell current customers, or simply attract more lower-tier customers. They can also calculate how many customers the CRM company needs to reach its goals.
Customer Lifetime Value (CLV)
Customer lifetime value (CLV) is the total amount of revenue earned over the entire time a person is a customer. Once a business knows CLV, it can work backward to determine how much to invest in acquisition and retention.
Business profit can be represented in a variety of ways, including net, gross, and operating profit.
Net Profit/ Net Income
Net profit, also referred to as net income, is the sum of all income minus all expenses. This includes operating expenses, any interest paid on loans, manufacturing costs, and all income streams.
Gross Profit/ Gross Margin/ Gross Income
Gross profit, also referred to as gross margin or gross income, is calculated by subtracting the cost of goods sold (COGS) from revenue.
Operating profit is calculated by subtracting the COGS and operating expenses from revenue.
3. Burn Rate and Cash Runway
Burn rate and cash runway, sometimes shortened to just “runway,” are two metrics that relate to how long a business can maintain operations based on its funds.
The burn rate is how quickly the business is burning through cash and is usually assessed on a monthly basis. It can be calculated as a gross burn rate or net burn rate.
- Gross Burn Rate: Sum of all monthly expenses.
- Net Burn Rate: Sum of all expenses plus income.
Runway relates to how long the business can operate before it runs out of cash. It’s typically measured in months and is calculated by taking the total cash available and dividing it by the burn rate.
Tracking expenses is vital for businesses because most must keep their cash outflows lower than their cash inflows, though there are a few exceptions to this, as is the case with venture capital-backed startups. Expenses fit into two broad categories: operating expenses and nonoperating expenses.
Any expense that’s directly related to doing business is considered an operating expense. This includes things like production costs, salaries, administrative costs, utilities, and mortgages.
Any expense that’s indirectly related to doing business is considered a nonoperating expense. This includes things like lending fees, interest, lawsuits, and restructuring costs.
5. Churn Rate
The churn rate refers to how many customers stop placing orders or leave the company within a specific timeframe. Churn rates are industry specific. For instance, the median churn rate for manufacturing is 25 percent, while energy and utilities sit at 11 percent, according to CustomerGauge. An unusually high churn rate signifies that the company needs to change something to improve customer satisfaction.
6. Operating Cash Flow (OCF)
Cash flow is the amount of money moving into a business or cash inflow, and the money moving out of a business, or cash outflow.
When broken out into operating cash flow (OCF), it represents the money the business is generating through typical operations. By tracking OCF, the business can gain insights into how much it can spend in the immediate future or if it’s best to cut back. OCF can also highlight issues with customers paying their invoices too slowly or not at all.
7. Working Capital
Working capital calculations demonstrate whether the business has enough liquidity to cover its immediate expenses. Working capital is determined by subtracting the business’s current liabilities from its current assets.
8. Budget vs. Actual
The budget vs. actual calculation, also called, the percent budget variance, tells the business how close it came to meeting its anticipated expenses. To calculate the percentage budget variance, divide by the budgeted amount and multiply by 100.
9. Aging of Invoices
Aging of invoices refers to how long it takes for an invoice to be paid.
Accounts Receivable Aging
Most businesses focus on accounts receivable aging. This references how long it takes the business’s customers to pay their balances. Naturally, a low average age is better, though it’s normal for the average age to reach 30, 60, or even 90 days in certain industries. As the average age grows, it can signify that customers aren’t paying their bills in a timely manner, which often means the business will have more trouble paying its expenses.
Accounts Payable Aging
Accounts payable aging references how long the business to pay its bills. It works like receivable aging. Longer aging periods can be good for a business because it means the business has more working capital. Still, it can also signify that the business is coping with cash flow issues. However, excessive aging is also associated with late fees and poor vendor relationships, damaging the business going forward.
10. Key Financial Ratios
There are many important financial ratios that provide insights into the business’s financial health, performance, and profitability. Formulas for the most used ones are grouped by type below.
Liquidity refers to your business’s ability to meet its current, short-term obligations. Liquidity ratios help measure working capital performance.
- Current Ratio: Current Assets / Current Liabilities
- Quick Ratio, Aka Acid-Test Ratio: (Current Assets – Inventories – Prepaid Expenses) / Current Liabilities
- Cash Ratio: Cash and Cash Equivalents / Current Liabilities
Leverage ratios are a measure of a business’s debt.
- Debt Ratio: Total Debt / Total Assets
- Debt To Equity Ratio: Total Debt / Total Equity
- Interest Coverage Ratio: EBIT / Interest Expenses
Efficiency ratios are used to understand how well a business uses its working capital to generate sales.
- Asset Turnover Ratio: Net Sales / Average Total Assets
- Inventory Turnover: Cost of Goods Sold / Average Value Of Inventory
- Days Sales in Inventory Ratio: Value of Inventory / Cost of Goods Sold X (Number of Days in Period)
- Payables Turnover Ratio: Cost of Goods Sold (Or Net Credit Purchases) / Average Accounts Payable
- Days Payables Outstanding (DPO): (Average Accounts Payable / Cost of Goods Sold) X Number of Days in Accounting Period (Or Year)
- Receivables Turnover Ratio: Net Credit Sales / Average Accounts Receivable
Profitability ratios are used to understand how well a business uses its resources to generate profit.
- Gross Margin: Gross Profit / Net Sales
- Operating Margin: Operating Income / Net Sales
- Return On Assets (ROA): Net Income / Total Assets
- Return On Equity (ROE): Net Income / Total Equity
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