If you set business objectives, you need to figure out how to track your progress toward achieving them. Looking at things like revenue and profit on the balance sheet or in your accounting software can only take you so far. You should continually seek more tangible ways to measure progress.
Key Performance Indicators (KPIs) are some of the best performance measurement tools available. Tracking relevant KPIs can assist in decision-making, help you set strategic objectives, and allow you to evaluate your business process in real-time.
Below, you’ll find everything you need to know about KPIs. We’ll outline what KPIs are and why they’re crucial. Then we’ll go over seven KPI meanings that are relevant to small business owners, helping you determine which are the right KPIs for your business goals.
What are KPIs?
According to Bernard Marr, a company specializing in intelligent business performance, “KPIs provide a way to measure how well companies, business units, projects, or individuals are performing in relation to their strategic goals and objectives.”
The company continues to describe KPIs as “vital navigational instruments” that provide a “clear picture of current levels of performance and whether the business is where it needs to be.” Whether you’re a young entrepreneur operating as a sole proprietor or the head of a multi-million dollar corporation, KPIs allow you to better evaluate your financial health as you pursue performance goals.
Defining and choosing the right KPIs for your business
KPIs are key metrics, but not all of them are the same. When you use KPIs, you want to make sure that they fall in line with your business goals. To help with this, you need to make sure your business goals are measurable and actionable. They should also include a reasonable time frame.
For instance, instead of setting a goal “to be the best company in the world,” your goal should be something along the lines of, “to be a Fortune 500 company by Q4 of 2020. To do this, we’ll increase revenues from XYZ product lines, while cutting operating costs.” Another example could be something like “Attract 500 new customers by the beginning of Q2. To do so, we’ll increase spending on social media marketing campaigns by $10,000 and will focus on sites like LinkedIn.”
Because the goals in these examples are measurable and actionable, business owners should have an easier time filling out their KPI dashboard. A good KPI is one that will allow you to track the critical success factors related to the goal. In our first goal, the company will want to focus on financial metrics related to revenues from the XYZ product line and operating costs. In the second example, the firm will want to track social media spending and customer acquisition.
For further clarification, consider the following KPI example. Imagine there are two businesses. One owns a brick-and-mortar store, while the other operates solely online. The company with the physical retail location’s KPI targets will include things like:
- Sales per square foot, a comparison of revenues versus rent costs
- Average transaction value, an indicator of how much shoppers spend in the store
- Shrinkage, a measure of loss of inventory not caused by sales. Loss caused by theft is a perfect example.
The online company doesn’t need to concern itself with these KPIs as much — if at all. Instead, the company should churn out a KPI report that is more relevant to its specific business transactions. Examples include:
- Conversion rate, comparing the total number of sales to website traffic
- Shopping cart abandonment rate, which shows how often users leave without completing their purchase
- Average order value, a measure of how much a customer spends when shopping on your site
You need to come up with your own KPIs to meet your business goals. The goals of one firm can vary drastically from those of another. You have some free reign in crafting KPIs, but you should make sure they meet these four criteria:
- They are actionable: Your KPIs should tangibly and objectively show you the improvements that you need to make to help your business.
- You can measure them accurately: You should have no problem tracking your KPIs. The best KPIs are easy to calculate and interpret. KPIs should be well-defined, quantifiable measurements.
- They are timely: Using old data exclusively won’t give you a measure of what’s going on currently. Old data is only useful if you use it as a comparison tool for current data.
- They impact the bottom line: Whether your goal is to improve net profit margins or customer satisfaction and retention, an improvement in your KPIs should result in progress toward your goal.
7 KPI meanings to consider
Although it’s up to you to determine which KPIs are best for your firm, we’ve included seven of the most relevant KPI meanings that small business owners should consider using.
1. Cash flow forecast
Cash flow forecasts let businesses assess whether their sales and margins are appropriate, and are consequently one of the most critical KPIs for small companies to track. To make your cash flow forecast, add the total cash your business has in savings to the projected cash value for the next four weeks, then subtract the projected cash out for the next four weeks.
Savvy business owners perform regular cash flow forecasts so they can identify problems in the early stages and make necessary adjustments. Cash flow forecasts can help businesses anticipate future surpluses or shortages. They can also help with tax planning and loan applications.
2. Gross profit margin as a percentage of sales
No business can achieve success if it’s paying out more to suppliers than it’s netting in sales. Gross profit margin as a percentage of sales demonstrates total profits compared to revenue.
First, find your business’s gross profit margin (GPM) by dividing your gross profit amount by your sales. Divide that value by your sales amount to find out how much of your GPM makes up your overall sales. Multiply that by 100 to express your gross profit margin as a percentage of sales.
The benefit of tracking this KPI over time is that you can easily quantify how much money you’re keeping against the amount paid out to suppliers.
As businesses retain more money, gross profit margin increases. But a decrease in gross margin as a percentage of sales could indicate that a company is overspending on its supplies. Owners would need to reduce overhead costs or increase prices on goods and services to compensate.
3. Funnel drop-off rate
Your funnel drop-off rate assesses the number of visitors who abandon a conversion process — or sales funnel — before completion. To calculate funnel drop-off, start by finding the number of visits for a particular conversion step in the funnel. Then, subtract the number of visits that occurred during the first step. Divide the value from the specific conversation step by the visits that took place during the first step to find the number of customers that you lost along the way.
By identifying when prospective buyers abandon the conversion process, companies can identify problems and make necessary adjustments to boost sales. With so many small businesses relying on the internet as a sales tool and with face-to-face interaction declining, funnel drop-off rate has become one of the most crucial performance indicators to track.
4. Revenue growth rate
Revenue growth is a financial KPI that refers to the rate at which a company’s income, or sales growth, is increasing. To find revenue growth rate, begin with your business’s total revenue for the current year. Next, divide current income by total revenue from the previous year to find the rate of growth. By calculating the revenue growth rate regularly, you can assess whether growth is increasing, decreasing, or plateauing, and by how much.
5. Inventory turnover
Inventory turnover measures the number of units sold or used in a given period and is valuable because it reveals a business’s ability to move goods. Inventory turnover can be found by adding up the cost of sold inventory, then dividing that total by the value of the inventory remaining at year’s end. Businesses should want to pursue a high turnover rate, but not by slashing prices significantly.
6. Accounts payable turnover
A company can’t keep its doors open for long if it fails to pay suppliers. Accounts payable turnover is a measure of the rate at which your business pays for goods and services in a given period. To find accounts payable turnover, add up the cost of total supplier purchases, and divide by average accounts payable. Once you know how much you spend on suppliers, you can determine if you need to take steps to reduce spending.
7. Relative market share
One of the most crucial performance indicators, relative market share shows you how much of a given market your company controls. Unlike internal metrics, relative market share reveals how a company is performing relative to its competitors in the same space. A small bump in profits may matter less if your company is falling behind its competitors. Once you calculate your relative market share, you can make strategic adjustments to your product and service offerings to improve long-term profitability for your business.
Get started with KPIs today
The most successful businesses use KPIs in some form or fashion to help them measure company success. As a small business owner, you should work to implement KPIs into your business strategy. Doing so can help you evaluate your progress and set new goals. There are various types of KPIs, and the opportunities to define KPIs are endless. Starting with the seven that we provided is an excellent way to get your company on track.