As a business owner, you need to know how to track your progress toward achieving your business objectives. Looking at things like revenue and profit on a balance sheet can only take you so far. You should continually seek more tangible ways to measure progress.
Key performance indicators (KPIs) are the best performance measurement metrics you can use to track progress towards your business goals. Tracking relevant KPIs can assist in decision-making, help you set strategic objectives, and allow you to evaluate your business progress in real-time.
Defining and choosing the right KPIs for your business
When you use KPIs, you want to make sure that they align with your business goals. To help with this, you need to make sure your business goals are measurable, actionable, and 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 2025. 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 can easily build their KPIs around them. 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 focus on financial metrics related to revenues from the XYZ product line and operating costs. In the second example, the company will 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 will have KPIs 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 quite 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 business 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.
9 KPIs that can help you grow your business
KPIs cover everything from financial metrics like profit margins and cash flow, to customer and marketing metrics like acquisition and return on investment. No matter what industry you’re in, these are 9 common KPIs you can use to track business growth.
1. Cash flow forecast
Cash flow projections, or cash flow forecasts, help businesses assess whether their sales and profit margins are appropriate—making this KPI one of the most critical metrics to track.
To make your cash flow forecast, start by estimating your sales to predict the amount of cash that may come into your business each month. From there, calculate your days sales outstanding—this tells you the average number of days it takes to receive payment from customers. Next, estimate the fixed and variable expenses your business will be responsible for paying each month. Finally, bring it all together. Add the current month’s projected receipts to last month’s cash balance, then subtract your projected expenses. The result is the current month’s projected cash flow. Repeat these steps for each month. A cash flow template may help.
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 by dividing your gross profit amount (revenue minus cost of goods sold) by your total revenue. Divide that value by your sales amount to find out how much of your gross profit margin makes up your overall sales. Multiply the result by 100 to express your gross profit margin as a percentage of sales.
By tracking this KPI over time, 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 may 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, determine how many people initiated a conversion process—or completed the first step of the conversion process. Then, subtract the number of people that completed a secondary step to find out how many visitors abandoned the process. Divide the number of people who abandoned the funnel by the total number of those who initiated the process to find the percentage of people who dropped off.
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 KPIs 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. The growth rate indicates how well your company is able to grow in sales over a specific time period. 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. This is a valuable metric because it reveals a business’s ability to move goods. A slow inventory turnover may be a result of slow sales or excess inventory. A faster ratio may indicate strong sales or insufficient inventory. Knowing how fast inventory moves can help you make more informed decisions on pricing, marketing, and purchasing.
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 and accounts receivable turnover
A company can’t keep its doors open for long if it fails to pay suppliers. Accounts payable turnover measures how often your business pays for goods and services in a given period. Understanding your accounts payable turnover can help you understand how efficiently your company pays off short-terms debts. 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.
On the flip side, a company can’t be profitable if customers don’t pay their invoices. Accounts receivable turnover measures how efficiently your company collects revenue. A higher ratio indicates that you collect money from customers more often throughout the year. A low ratio may present an opportunity to collect on outstanding receivables more often and improve your cash flow. To calculate accounts receivable turnover, divide your net credit sales by average accounts receivable.
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.
Finding your relative market share requires a little bit of research into your biggest competitors. A competitive analysis can help you identify your major competitors and their sales and revenue numbers. Determine your relative market share by comparing your market share with your competitor. Divide your market share by their market share and multiply by 100. Or, compare sales with your biggest competitor—just divide your sales by their sales.
8. Customer retention
It’s more costly to attract new customers than it is to retain existing customers. Plus, understanding your customer retention metrics can help you zero in on your most valuable customers and strongest demographics, so you can adjust your sales and marketing strategies accordingly. For these reasons, customer retention is a KPI every small business owner should have on their radar.
Track customer retention by keeping tabs on customer churn rate (how fast and often customers decide to stop doing business with your company) and repeat purchase ratio (how often customers return to your business to make a purchase after their initial purchase). A high churn rate or low repeat purchase ratio is a good indicator that there’s a problem with your sales funnel or customer support system.
9. Quick ratio
The quick ratio measures your company’s ability to pay off debts with the cash or near-cash assets you have right now. Knowing how quickly you can pay back your business debts, especially during times of economic uncertainty, is important for every small business owner. Use this ratio to monitor your liquid assets so you’re never caught off guard.
To calculate your quick ratio, first add up all your current assets, including cash, cash equivalents, and accounts receivable. Then, add up all your current liabilities, including loans, interest, accounts payable, and taxes. If you hold inventory, subtract your inventory amount from your current assets. Divide the result by total current liabilities to get your quick ratio. A healthy quick ratio should be greater than 1. Anything less indicates more debt than assets.
The quick ratio only includes assets that can be converted into cash within 90 days. The current ratio, a very similar metric, is a bit less conservative. This ratio includes all assets that can be converted into cash within one years—including inventory.
Get started with KPIs today
The most successful businesses use KPIs in some fashion to help them measure company progress and success. As a small business owner, you should always work 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. Create KPIs that work for your business and align with your business goals.