KPIs Every Small Business Owner Should Track & Manage
Peter Drucker, world-renowned author on business management theory and practice, has been quoted as saying, “If it cannot be measured, it cannot be managed.” One way to identify and measure the current state of your small business is by using key performance indicators (KPI). KPIs are metrics, but not all metrics are KPIs. KPIs are specific metrics that directly affect your company’s ability to achieve its operational and financial goals. There are hundreds of examples of metrics that businesses can track—some which are very industry-niche—but there are some that nearly all businesses should track.
One of the most simple, yet important, KPIs is revenue growth. This KPI can be measured at the organizational level, but if there are differing service lines, it’s advantageous to measure growth by service line—but be mindful of management expectations, too. For example, a new service line will experience a much quicker rate of growth compared to existing service lines. In this instance, it should be anticipated that a new service line will experience a higher rate of growth than a mature line. The growth KPI is the measurement, but management must understand the operational components that drive this growth to effectively manage your business.
Once the operational components of growth are understood, management should then consider the profitability of that growth. Another simple, yet insightful, KPI is gross profit margin. Simply calculated, this is revenue minus cost of goods sold. This fundamental metric will quantify how much profit on each sale is going to cover overhead. If you sell a widget for $10 and it cost you $2 in direct materials and $1 in direct labor to produce that widget, your gross profit is $7 and your margin is 70 percent. A company’s gross margin is imperative to ensure it is competitive with the market and will ultimately sustain financial health. A stronger than average gross margin will allow for better opportunity to cover overhead costs with a goal to ultimately result in profit. Gross margin is a KPI that must be measured continuously, but to really ascertain value, it also should be benchmarked with your industry.
To be profitable, we’ve learned gross profit must be high enough to cover overhead costs, so management must be mindful of these costs as well. Another simple and effective KPI is to measure overhead as a percentage of revenue. Overhead costs are generally fixed (or continuous) costs, but these can fluctuate over time. One powerful process and tool management should consider is to create a budget. A simple budgeting process will consist of establishing goals for revenue and gross profit margin and overhead cost management. Understanding the level of overhead costs needed to operate a business is paramount. Though the dollar amount of overhead can vary, overhead costs as a percentage of revenue cannot exceed the gross profit margin over the long term. Simply stated, if your gross profit margin is 70 percent, but overhead costs as a percentage of revenue exceed 70 percent, operating cash flow will suffer and, without financial intervention, the business will ultimately go bankrupt.
As referenced above, a business is not financially viable if it doesn’t have the recurring positive operating cash flow (OCF) to sustain its operations. OCF as a KPI simply measures money flowing in and out of the business from operating activities; it does not include investment activities or noncash expenses such as amortization and depreciation. To learn more about the cash flow cycle, subscribe to our Small Business Newsletter to gain access to a helpful resource that covers this and other key financial and accounting metrics.
In short, you need to measure the change in working capital—another KPI all business owners should track. Working capital is a measure of a business’s liquidity and calculated as the current assets divided by its current liabilities. If this outcome is greater than 1, the company has enough current assets to pay its current liabilities; the higher this ratio, the stronger the company’s short-term financial position. However, a consistently downward trending working capital ratio indicates the company will be challenged to pay for its liabilities and will require management analysis of operations.
In today’s world of infinite data, it is easy to become overwhelmed when determining what information to use to better manage your business. Simple yet powerful KPIs are designed to filter out the “noise” and can assist management with decision making to improve financial performance. When tracked consistently and accurately, these indicators help small businesses manage what they measure. Measuring and tracking KPIs is not a one-time exercise; rather, this requires a consistent and disciplined effort by management, who must continuously work on improving KPIs to achieve the business’s operational and financial goals.
Do you need help getting started? Contact us to speak with a BKD Trusted Advisor™ or visit our Outsourced Accounting Services page to learn how we can assist your small business with implementing and mastering these KPIs.