When running a business, particularly a small business, growth is important. It’s only with sustained growth that small start-ups can become fully fledged, successful business. This may seem straightforward but how do we measure growth? After all, every business is different and each will have their own definition of success. This is where key performance indicators or KPIs come in.
KPIs are specific metrics that can be identified and analysed, in order to ascertain whether a business is meeting targets, growing and is generally financially healthy. There are many different types of KPIs but most companies will only focus on specific metrics which are most relevant to them. Benefits of utilising KPIs, include insight, better decision making and the ability to create a roadmap for the business.
With this in mind, what key performance indicators are best for you and your business?
Goals
Before you establish which metrics you will chose as KPIs, you need to create long-term goals. It’s only by establishing the desired end result that you can pick the right aspects of the business to measure and therefore analyse. For example, if the goal is to increase revenue, then you should focus on sales. Whereas, if your goal is about acquiring new customers, then you should focus on marketing, social media and interaction.
Setting a clear goal will help to streamline the entire process and identify specific KPIs which will be particularly useful.
Key Performance Indicators
As we have established, there are countless different KPI’s and each business will decide which metrics are best for them. However, there are some general KPIs to look at, which will benefit any business who chooses to use them.
Profit Margin
One of the most useful indicators of how healthy a business may be, is profit margin. The profit margin is a ratio which identifies how much of a company’s revenue is profit. Obviously, the more profit a business is bringing in, the more likely they are to grow.
There are three types of profit margin that can be considered:
Gross profit margin– Revenue minus direct costs (raw materials, wages etc.).
Operating profit margin – Revenue minus operating costs (utilities, marketing etc.)
Net profit margin – revenue minus all costs.
Each of these metrics can offer valuable insight into your business, however your net profit margin will provide a general snapshot of financial health. This is a good indicator to continually track as any decrease in profit could be a cause for concern. It may mean that you have to cut costs or raise prices in order to continue to meet your goals.
Customer Retention
Businesses are built on their ability to find and retain customers. New customers are much more expensive than existing customers and therefore retention is paramount. You may be keeping track of sales but these numbers don’t tell you where those sales are coming from. KPIs which breakdown what proportion of your sales are coming from existing customers, can provide valuable insight into retention. If you’re having trouble keeping customers, this could be a warning sign for the future, prompting you to make beneficial changes.
Acid Test
The quick ratio or acid test is a useful metric which identifies cash-flow and short-term liquidity. This is important because positive cash flow is one of the best indicators for overall business health and the potential for growth. In some instances, good cash-flow is a better indicator of long-term success than general profit.
Calculating the ratio is relatively simple and involves dividing liquid assets (cash and accounts receivable) by total liabilities (costs). A high ratio indicates that the business is healthy and has a greater potential for growth. Whereas a ratio below 1.0 could indicate that the business may have trouble covering costs and changes may need to be implemented.
These are just some ways in which small businesses can utilise KPIs in order to gauge growth. However, there are many other measurements that can be used, helping you to keep track of the company.
When starting a new business, it can be a steep learning curve, especially with the many financial factors involved. Fortunately, there is help available. The team at Salhan Accountants offer expert advice and services, with financial solutions for every type of business.
