How to use KPIs to better understand your business

January 22, 2020

Running your business is a full-time job. It's common for business owners to get swept up in business operations and they can often overlook the importance of calculating and analyzing key performance indicators (KPIs). These KPIs can provide valuable insight into the health of your business and help you to determine where problem areas lie.

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There are many types of KPIs available to provide this insight, but we're going to focus on ratio KPIs. We recommend regularly checking the following:

How are you financing your business?

Leverage ratios, such as debt-to-equity or interest coverage ratios, can provide valuable insight into how your company uses debt (also called leveraging).

Leveraging isn't necessarily an indicator of poor financial health. For instance, borrowing can be an indicator that the company has an increased demand for its products and is experiencing significant growth.

Once you have calculated your leverage ratios, you should assess whether or not your debt level is sustainable.

Can you meet your current financial obligations?

Liquidity ratios determine if your company can pay off its short-term debt obligations. In other words, how quickly can your company convert its assets into cash. The higher the ratio, the better? Not exactly.

An excessively high ratio could indicate that you could better use your assets to invest into the company.

After completing this analysis, you should consider whether or not you need to borrow or raise additional funds.

Are you utilizing your assets effectively?

Turnover ratios (or activity ratios) such as asset turnover, inventory turnover, or receivable turnover all provide different insights into how efficient your company is in converting those assets into cash or sales.

Calculating these ratios over time can provide indications of seasonality or changing consumer preferences.

Once these ratios are calculated, you should look at how you can better manage your assets to increase revenues.

How profitable is my business?

Profitability ratios are the most popular ratio group. Profit margins and return on equity are best calculated on a consistent basis for comparison purposes and analyzed in conjunction with other ratios such as those mentioned above.

Fragmenting the analysis by service type, product line, or department can yield even more valuable data.

Look at your profitability ratios to find out what they tell you about your business growth and whether or not your company is maintaining its competitive edge.

What am I missing?

There are other questions you should ask yourself:

  • Why is it taking so long for my clients to sign contracts with my business?
  • If one of my vendors goes out of business, what will be the financial impact to my company?
  • Is my marketing spending yielding results?
  • Is my cash flow healthy enough to hire more staff?

These are some of the other KPIs that can provide additional insight.

BDO can help

We can work with you to interpret your financial results to better drive your business. Our Cloud Bookkeeping Services team provides clients with accurate financial data that they can use to calculate their KPIs. Contact us to find out how we can help your business.