Key performance indicators (KPIs) are used to measure the health of your business and to set and track your goals. While your KPIs will differ based on your company’s growth roadmap, industry and other unique factors, there are many useful KPIs that drive all businesses.
We spoke to three finance and accounting professionals from our community of elite fractional CFO’s and finance experts. Accountant Keri J., CFO Perry T. and financial analyst Malisa N. recommend their most useful KPIs and best practices for developing and reporting your metrics.
Q: Data is at the core of goal development, which enables KPIs to be specific to your business. What do businesses need to create well-tailored KPIs and KPI dashboards?
Perry: When you’re thinking about KPIs, think of root cause analysis. You’ve probably heard of Lean [methodology] and the Five Whys. If something happens, I ask “Why?” at least five times to get to the very root. Why? Because then you’ll have KPIs that really are drivers, that are not superficial, but are the root of what is driving success or failure in the company.
Malisa: What I find companies often do is realize they want to be able to understand something at a lower level than they have been recording. [Say] I have 12 different products, but I have only been recording revenue as one product, and I don’t know how to parse that data out. So, now I have a hard time understanding profitability by product. The main message is put your data in as low a level as you can reasonably afford.
Keri: I also find that many companies need to go back to their data sources to validate the accuracy of the information they are analyzing.
Q: KPI development is not a one-size-fits-all approach. However, what are universal KPIs that all businesses should be tracking regardless of size, industry or growth?
Keri: Three KPIs that companies should be tracking are working capital, profit margin and debt to equity ratio.
Perry: The number one reason companies fail is because they run out of cash. I believe the senior team should take into account the impact on cash of every major decision they make. Cash has got to go from the sales to the bank account as fast as possible, and that’s called your cash conversion ratio. Especially if you’re a startup, then [you can track] cash divided by burn rate. So, you know you’re gonna burn some cash in the front end, but how much runway do you have? And another one too is the opportunity win rate of every opportunity you have.
Malisa: You always have to have your income statement and some kind of comparison point, whether that’s your budget or your forecast. Those are going to drive 90 percent of the questions of how you operate your business. Also cash KPIs regardless of industry, whether that’s how many days of AR [accounts receivable] outstanding you have versus your average sales cycle. Regardless of whether you’re an equity business or a bio-style business, your collections have to be higher, and that’s why we’re all here.
Q: How will core KPIs for growth companies and lifestyle companies differ?
Perry: If you’re looking to grow quickly, the lifetime value to customer acquisition cost, and being the point over hire. I like opportunity win rate of all the opportunities, as that’s the sum of all your conversion ratios.
Malisa: Your lifestyle companies are going to just be: how do I maintain my income? Those are pretty standard. Income statement, balance sheet and maybe some sales KPIs. For a startup or something with fast growth, you really want to talk about how much your revenue is costing you and what your growth strategy is.
Perry: If you’re looking to maintain: monthly recurring revenue. Once you reach a certain size, and you have recurring revenue, what is your monthly recurring revenue? For companies of all sizes, but maybe once you get a little bit more established [and things aren’t moving so fast], some softer subjective measures like employee engagement are really important.
Q: If you’re looking to pitch to buyers or investors, what are the first KPIs they want to see?
Keri: The VCs I work with always want to know the gross profit margins, discretionary earnings and burn rate.
Malisa: When you’re showing your investors, obviously, your debt ratio is important, but also your ownership dilution.
Perry: Revenue is vanity. Profit is sanity. Cash is reality. At any one point in time, the value of a company really is its discounted cash flow. It’s the ability to generate cash over time. So, I like cash generated per dollar of sales. And I think a lot of investors like to see the total addressable market. In other words, how big is the market for your services?
Q: Where can businesses start with qualitative KPIs? What qualitative KPIs can businesses easily track?
Malisa: It comes down to the question: How do you know whether you have good customer service? Will they come back and buy more? That’s where the customer lifetime value KPI comes into play. Also, what is your renewal rate? That would be one way to be qualitative. But then, you can also do customer retention or customer support. How long does it take for somebody to get back to [the customer] or resolve an issue?
Perry: Customer satisfaction or net promoter score. How would you rate your likelihood to refer somebody between one and 10? And then employee engagement. Happy employees make happy customers.
Q: How do you know if your KPIs are still the right ones for your business?
Malisa: You need to have a target, and you need to have a reason for that target. I worked for a company, and they said, “Okay, our AR aging has gotten out of hand. So, everybody has 90 days to get their collections down to within 30 days.”…You have a goal at the beginning of each budget or forecast cycle, and as soon as you start getting variances from that, if you can phone in why and start tracking the cause of the variance early in your operation cycle, that’s when you introduce a new reporting process into your operation cycle… Also, I think it’s important to listen to investor calls, as well as to your own investor calls, and find out the questions the market is asking
Perry: [Revisit your KPIs] at least quarterly to just think about it. Are they serving us? And then if we see something happening in the business, and we think, “Why didn’t our KPIs catch that?” then maybe we go back and ask the Five Whys.
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KPI Glossary
AR outstanding: Also known as Days Sales Outstanding (DSO), this metric measures the average number of days between a sale and the received payment.
Average sales cycle: The average number of days between the first contact with a customer to the closed deal.
Burn rate: The rate at which a company loses money, or the amount of money a company spends per month.
Customer acquisition cost (CAC): The cost and resources required to gain a new customer, used with customer lifetime value to evaluate the ROI of acquisition efforts.
Cash conversion ratio (CCR): A comparison of your company’s cash flow to its profits, measured by operating cash flow divided by net income.
Customer lifetime value (CLV): The total revenue generated by a customer across their entire journey with the company, typically measured by adding revenue generated at specific touch points. CLV is often compared with customer acquisition cost (CAC) to determine sustainable growth.
Debt-to-equity ratio: This leverage ratio indicates how much debt you use to operate your business in proportion to your equity. It’s measured by total liabilities divided by shareholders’ equity and helps investors understand risk.
Discretionary earnings: Used in the valuation and sale of a company, seller’s discretionary earnings tells potential buyers the total financial benefit that a business owner derives from their business annually. It measures profit before taxation and interest.
Gross profit margin: Gross profit margin measures profitability. It’s calculated as total revenue, less the cost of goods sold, divided by total revenue.
Monthly recurring revenue (MRR): Your MRR measures your predictable monthly revenue by multiplying your total customers each month by average revenue generated per customer.
Net promoter score: A single survey question that asks a customer to rate their likelihood of recommending a product or service to a friend.
Opportunity win rate: Divide your opportunities won by your total opportunities in a given time period to understand how effectively leads are generated into sales.
Total addressable market: The total potential demand for a particular product or service, which demonstrates growth and upside potential.
Working capital: Your amount of readily available capital calculated as current assets less current liabilities.
