Running a finance department isn’t easy. Keeping employee morale on the up-and-up is one thing – crunching numbers, running from dataset to dataset, and reconciling errors all day can be exhausting. We’ll get to that.
But first, let’s talk about KPIs. There are a lot of KPIs to keep track of. You’ve got your operating cash flow, free cash flow, cost of goods sold, and many other complex-sounding items.
Well, have no fear.
This article’ll give a simple rundown of the most important finance team KPIs.
Not only that, but we’ll look at other measures to determine if your team is working well.
Many of the finance team KPIs are related, so there’s actually not as much to keep track of as it at first seems. Each metric works with the next to provide a fuller picture of your financials and help you successfully manage your business.
1. Working Capital
We’ll start with working capital, a metric that provides a snapshot of your company’s financial health.
Working capital measures the company’s ability to meet short-term obligations. It looks at current assets and current liabilities – current, by the way, usually means 12 months in the finance world.
So, current liabilities are any obligations due within 12 months. Assets are considered current if you could quickly convert them into cash. Examples include marketable securities and accounts receivables, as well as cash itself. A building is an asset, but not a current asset – it’s not the easiest thing to quickly convert into cash!
To calculate working capital, simply subtract current assets from current liabilities:
Working capital = current liabilities – current assets
A positive result means you have enough cash to continue operating over the next year, while a negative one means you’ll need to make adjustments to remain solvent.
2. Current Ratio
The current ratio, also known as the working capital ratio, is a quick and easy measure of how much liquidity your company has.
The current ratio formula is:
Current Assets / Current Liabilities
What’s an ideal result? That can depend on your industry and business model. However, we can definitively say that anything less than 1 is not ideal – that means your business will need to increase income or decrease expenses to keep operating. Other than that, a general “Goldilocks zone” is a result between 1.5-2.
Can your result be too high? Yes, absolutely. If your current ratio far exceeds 2, it means you have a lot of excess cash lying around – cash that could be invested, whether that’s in a savings account or in strategically expanding your operations.
3. Cost of Goods Sold
Items you produce and sell have costs – costs of materials, labor costs, etc. In finance speak, this combined cost is known as cost of goods sold or COGS. Calculating COGS helps you set prices that guarantee a healthy profit, identify production inefficiencies, and optimize your inventory levels.
The formula for COGS is:
Starting Inventory + Purchases – Ending Inventory = COGS
Starting inventory is the cash value of your inventory at the beginning of the accounting period. Purchases are what you spent on manufacturing costs during the period, and ending inventory is the cash value of what’s left over at the end of the period.
4. Gross Profit Margin
Gross profit margin looks at revenue in relation to your cost of goods sold (remember what we said about all these different metrics being connected?). The formula for gross profit margin is:
(Revenue – COGS) / Revenue
By measuring revenue against COGS, gross profit margin tells you whether the money you’re earning is worth the costs of production. Are you getting enough bang for your buck, or should be making adjustments to production methods?
5. Net Profit Margin
What’s the difference between a gross profit margin and a net profit margin? No, we’re not trying to set up a joke.
The answer is that, while the gross profit margin focuses on revenue left over after the cost of goods sold, net profit margin takes a wider view: it considers all expenses, not just COGS. So to calculate net profit you’d add up COGS, taxes, interest, depreciation and amortization, operating expenses – everything!
By examining all of these expenses, you’d understand how much money you’re actually retaining from making sales – your total, net profit.
The formula for net profit margin is:
Net Income / Total Revenue * 100
6. EBITDA
EBITDA stands for earnings before interest, taxes, and depreciation and amortization – ok, that’s a bit of a mouthful. This metric is commonly used by businesses looking to sell as it provides a fairly simple overview of how profitable a business’s core operations are.
Since it’s a standardized metric, it’s also often used to compare businesses within the same industry.
EBITDA is pretty easy to calculate. The formula is:
EBITDA = Net Income + Interest Expenses + Taxes + Depreciation & Amortization
7. Cash Conversion Cycle
The cash conversion cycle shows the number of days it takes you to transform your inventory into cash. Not in a magical, Harry Potter kind of way, of course, but through sales and the collection of accounts receivable.
Usually, the goal is to shorten your cash conversion cycle – why have money tied up in production or storage costs when you could be using it to invest in growth or build up an emergency fund?
The cash conversion cycle does involve other metrics which can be a bit annoying to calculate: these include days inventory outstanding (DIO), days sales outstanding (DSO), and days payable outstanding (DPO).
The formula for calculating cash conversion cycle is:
Cash conversion cycle = DIO + DSO – DPO
To improve your cash conversion cycle, focus on selling inventory faster, extending supplier repayment terms (which keeps money in your hands as long as possible), and improving your accounts receivable process.
8. Burn Rate
Every company has a cash runway – a measure of how long it can keep up operations before running out of money. The rate at which you’re moving along your cash runway is known as your burn rate. A high burn rate is sometimes ok, but it’s not ideal – that’s especially the case if you’re a startup short on finances, and funding is drying up as the result of a difficult economic landscape!
The formula for determining your monthly burn rate is:
(Starting Balance – Ending Balance) / Number of Months = Monthly Burn Rate
Reduce your burn rate and extend your cash runway by boosting your liquidity levels.
9. Operating Cash Flow
Operating cash flow (OCF) is cash generated by your core, day-to-day operations. The higher the operating cash flow, the better. Not only does a high OCF mean your business is earning more profit, but also that you won’t have to rely on outside investors to continue operating.
How do you raise operating cash flow? One of the best ways is by shortening your cash conversion cycle (see above).
The formula for operating cash flow is:
OCF = Total revenue – Operating expenses
10. Free Cash Flow
Free cash flow (FCF) is the amount of money a company has left over after paying for operating expenses and capital expenditures (money spent on purchasing and maintaining physical assets like buildings or equipment).
It tells you how much money you have to expand your business, invest in research and development, and pay out to shareholders.
The formula for calculating free cash flow is:
FCF = Operating cash flow – capital expenditures
11. Cash Forecast Accuracy
Cash flow forecasting is one of the most important aspects of successfully managing liquidity. By projecting future cash flows it helps you strategize spending, letting you know when you can afford certain expenses and how to avoid liquidity shortfalls.
But your forecasts are only as useful as they are accurate. Keep tabs on the accuracy of your forecasts over time so you can make adjustments as needed.
To calculate the accuracy of your cash forecast, use this formula:
(Actual cash balance – forecasted cash balance)/forecasted cash balance
12. Days Cash On Hand
What if all your income were to suddenly dry up? Days cash on hand tells you exactly how many days your business could continue to operate. This is the most granular measure of liquidity, focusing specifically on cash you have right now (not projected future cash or loans).
The formula for days cash on hand is:
Total available cash/average value of disbursements per day
What Does a Well-Run Finance Team Look Like?
So, we’ve covered the type of thing you’d expect when you hear “KPIs” – quantifiable metrics with hard numbers. But there’s one major factor we’ve missed: employee satisfaction. We are talking about things finance teams have to look at, after all! Employee satisfaction is directly connected to the performance of your team – in other words, the successful management of every KPI listed above. That begs the question:
How Can Finance Leaders Keep Tabs on Employee Satisfaction?
The first way is through a numerical indicator: churn rate. If you have employee revolving door syndrome, one thing you should do is conduct exit interviews – get each person’s honest appraisal of the situation. If they’re leaving because they’re dissatisfied, ask for tips on how things could be improved.
Besides that, though, one simple way to keep tabs on employee satisfaction is through surveys. Surveys might ask questions about work-life balance, how engaging employees find their work, and whether or not they feel they have enough opportunities for advancement. Ensure these surveys can be filled out anonymously to get honest answers.
One-on-one meetings are another option, but make sure they’re not perceived as confrontational. Encourage employees to say whatever’s on their minds since you’re collecting data to create a more content environment.
Next, how many of your employees are actually using their learning budget?
This can indirectly show whether employees are satisfied – if they do use them, it means they’re invested in their work and want to bring more to the table.
Do You Have Too Many Tools?
Many finance teams have too many tools. We could call this “tool overload syndrome,” and it’s something our staff has personal experience with. We’re willing to bet you have at least one tool you don’t use, or only use one or two features of. If that’s the case, is it really worth the subscription cost?
Besides cost, it just clutters things. Finance teams need to be focused. Ask what your goals are, and then find one or two pieces of software that help you achieve those goals. You don’t need all the bells and whistles of some of these huge, bulky TMS.
How Much Time Are You Spending on Reconciliation?
Probably too much! It can often seem like by the time finance teams are done reconciling, the day’s over.
Typically, the reason for so much time spent on reconciliation is that treasury departments are still using spreadsheets.
Now, we don’t hate spreadsheets. Sometimes, they can get the job done. But the truth is that you’re putting your finance team at a massive disadvantage by relying on spreadsheets.
For one, spreadsheets are massively prone to error. Next, using them will never allow you to establish your real-time cash position. Why? Well, by the time you consolidate all your data it’s necessarily out of date.
Spreadsheets also mean siloed data – version control becomes a problem as it’s difficult to determine who has the most up-to-date information. It’s much better to have a single, real-time source of data such as that offered through banking APIs.
Overall, reducing the number of tools you use – and reducing or even eliminating time spent on mundane, manual tasks – helps boost employee satisfaction levels and overall financial performance.
Does Your Business Have a Cash-Centered Culture?
At the end of the day, the main focus of a business is cash: earning cash through sales, saving cash, and spending cash when appropriate. This is hard to argue with.
Why, then, do so many businesses lack a cash-centered culture?
A cash-centered culture is exactly what it sounds like – you place more emphasis on cash and cash flow management, making it your business’s top priority. You build a strong liquidity position and forego debt financing almost entirely.
This means shortening your cash conversion cycle and boosting operating and free cash flow. This way, you can operate a tight ship – you don’t have to worry about timing loans to pay for debts, or having enough liquidity to pay for unplanned expenses. Rather, you balance out liquidity to pay for sustainable growth, while leaving enough to tackle crises – and take advantage of opportunities – as they arise.
And, thanks to technology, the modern treasury team doesn’t need to wait for accounting to crunch numbers before taking action.
Trovata focuses entirely on cash – the core of your business. Through the power of banking APIs, we specialize in helping you forecast cash flow, move cash, and dig deep into your data to uncover actionable insights.
Ready to learn more? Schedule a demo of our cash management platform today!
