Tax and pensions
Cash basis tax return vs. accrual accounting: What’s best for your small business?
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When running a small business, you can’t rely on your gut instinct all the time. Key performance indicators (KPIs) also have a part to play, especially when it comes to financial reporting. When measuring the financial health of your company, it’s best to be objective rather than subjective, so you can make informed and data-backed decisions.
One way to objectively track the health of your business is through KPIs, or key performance indicators. These are metrics that can help you chart progress toward a variety of business goals. Below we’ll explore 14 financial KPIs, their uses, formulas, and other tips to help you make informed financial decisions.
Financial KPIs measure business performance against specific financial goals. These could be gross revenue or turnover, net profit or debt to equity ratio.
They show the financial health of a business against internal benchmarks, competitors, and even other industries. Financial KPIs are widely used in strategic planning and reporting to help people decide where to focus their investment.
Keeping close tabs on your business’ financial performance is essential to long-term success. Below, you’ll find fourteen important financial KPIs that you can use to measure your business’s financial health and boost your growth.
Indicates: Overall profit
Format: Percentage
Formula: (revenue – the cost of goods sold) ÷ revenue = gross profit margin
Your gross profit margin shows how much of your revenue can be considered profit after factoring in operating expenses like the total cost of production. Your gross profit margin should be large enough to cover your fixed (operating) expenses and leave you with a profit at the end of the day. You can then use the extra earnings for things like:
Marketing campaigns
Dividend payouts
Non-fixed costs
Indicates: Overall profit minus the expenses
Format: Number
Formula: total revenue – total expenses = net profit
Your net profit is your bottom line—the amount of cash left over after you’ve paid all the bills. Also known as net income, net profit accounts for both direct and indirect expenses and is an important component of operating cash flow.
Indicates: The percentage of revenue as profit
Format: Percentage
Formula: (total revenue – total expenses) ÷ total revenue = net profit margin
Net profit margin tells you what percentage of your revenue is profit. However, unlike the gross profit margin, it accounts for all expenses, not just direct costs. This metric helps you project future profits and set goals and benchmarks for profitability.
Indicates: The percentage of cash received from credit sales
Format: Percentage
Formula: net credit sales ÷ average accounts receivable = accounts receivable turnover ratio
Your accounts receivable turnover ratio measures how well you collect cash from credit sales. A higher ratio for accounts receivable turnover is better than a lower ratio because it shows that your customers are paying you faster. This in turn accelerates your cash conversion cycle—in other words, more cash comes in quickly.
Indicates: The percentage of cash that is liquid
Format: Percentage
Formula: current assets ÷ current liabilities = current ratio
The current ratio provides you with a measure of liquidity. You can use this KPI to determine if you have the necessary cash on hand to fund a large purchase. Creditors may also use this formula to determine the likelihood of you repaying a loan.
Indicates: The percentage of short-term debt that can be paid
Format: Percentage
Formula: (current assets – inventories) ÷ current liabilities = quick ratio
The quick ratio or acid test ratio is another KPI that’s extremely relevant to a company’s financial health. The quick ratio highlights a company’s ability to pay short-term financial liabilities immediately. The quick ratio is a better indicator of the ability to do so than the current ratio, as the current ratio measures a business’s likelihood of making payments within a year.
Indicates: The percentage of potential revenue from a customer
Format: Percentage
Formula: net expected lifetime profit from customer ÷ cost to acquire customer = customer acquisition ratio
The customer acquisition ratio compares how much revenue you receive per new customer. If your customer acquisition ratio is:
Less than one: Indicates that you’re spending too much to acquire customers and losing money as a result
One exactly: Indicates the customer lifetime value equals the cost to acquire them
More than one: Indicates that your investment is worthwhile
The higher the number, the better. For instance, imagine the equation yields a customer acquisition ratio of three. This means you’re earning $3 for every $1 you spend to acquire a new customer.
Indicates: The return on shareholder’s investment
Format: Number
Formula: net income ÷ shareholder equity = return on equity
The return on equity KPI shows how successful you are at generating profit from shareholders’ investments in your business, because a unit of shareholder equity represents total assets minus total liabilities. In other words, it reveals how much you make from each pound invested in your business.
Indicates: The amount of time needed to convert cash into inventory
Format: Number
Formula: days inventory outstanding + days sales outstanding – days payable outstanding
The cash conversion cycle (CCC) allows your company to assess its efficiency in terms of converting its working capital to inventory, selling said inventory, and collecting cash from these sales. The lower the CCC, the more effective your business is at selling products and converting those sales to working capital.
Indicates: The percentage of income received from an asset
Format: Percentage
Formula: net income ÷ average total assets = return on assets ratio
The return on assets (ROA) is a testament to your company’s ability to turn liquid assets into income, not through sales but through utilisation. Say your company works with machinery to produce a product. That machine's output is directly correlated to net income based on how efficiently it can produce the product. So you take your net income and divide it by the average number of machines your company has and you’ll get the ROA.
Indicates: The percentage of debt in relation to equity
Format: Percentage
Formula: total debt ÷ shareholder equity = debt to equity ratio
The debt-to-equity ratio proves its importance by showing how a company is acquiring debt in relation to net assets. A higher debt-to-equity ratio may mean that the company has taken on too much debt to sustain or influence growth. This can be seen as a red flag to some, indicating that the company may not have enough assets to cover its debt if needed.
Indicates: The percentage of SG&A in relation to sales
Format: Percentage
Formula: total SG&A ÷ total sales = SG&A ratio
Looking for a place to cut costs? Try running a selling, general, and administrative (SG&A) ratio to start. Your sales, general, and administrative expenses are all outgoings that aren’t directly tied to creating your product. This could be, for example, those miscellaneous office expenses that pile up and take a cut from your bottom line. In general, the lower the SG&A ratio, the better.
Indicates: The percentage of operating cash in relation to current liabilities
Format: Percentage
Formula: operating cash flow ÷ current liabilities = operating cash flow ratio
Very similar to the current ratio, the operating cash flow ratio also looks at liquidity. However, the operating cash flow ratio is more focused on short-term current liabilities and can help answer the question: “Do we have enough cash to cover our current short-term financial obligations?” You want this ratio to be high, as it shows you have more cash on hand to cover your current liabilities.
Indicates: How quickly you’re able to put together your company budget
Format: Number
Formula: days for budget preparation + authorisation + implementation = budget creation cycle
The budget creation cycle yields different results than the standard ratios and outcomes we’ve looked at in this article, but its importance cannot be underestimated. Being able to gauge how quickly you can get a company budget variance drawn up based on historical data speaks to both your understanding of your business model, business operations, sales growth, and return on equity, as well as the financial efficiency of your company.
Not every KPI will be relevant to your goals as a business owner. Having the right accounting systems in place is a major step in the right direction, but you'll need to know how to set the right goals to push your success over the finish line. Using the acronym “S.M.A.R.T.E.R.” can help you better nail your goals down. Here’s the breakdown:
Specific: Detail what you’re looking to achieve
Measurable: Put a number to your goal
Attainable: Take baby steps and try to catch the low-hanging fruit first
Relevant: Use KPIs that are relevant to your business
Time Frame: Put a timeline on your goal
Evaluate: Check-in on your progress
Re-evaluate: Throw out what isn’t working and capitalise on what is
Choosing S.M.A.R.T.E.R. KPIs ensures that these key metrics are working well for you, and increasing your chances of meeting your short-term and long-term goals.
With QuickBooks, you can simplify your financial planning and reporting. Our intelligent, powerful software is designed to adapt to all modern business accounting needs, and provides a comprehensive picture of your financial health, using your chosen KPIs.
QuickBooks is Making Tax Digital-ready and HMRC approved, fully equipped to meet the needs of a fast-paced business. Track invoices, manage expenses and see a real-time snapshot of your business’ financial health.
Try QuickBooks today, and manage your business finances in one place, from anywhere.
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