Both small and large organizations can access quick insights into internal operations through key performance indicators (KPIs).
KPIs for budgeting and forecasting are especially useful to monitor and regulate a company's financial health and operational efficiency. When healthy KPIs are maintained, organizations can ensure they are meeting all obligatory liabilities, while perpetuating average sales and revenue.
However, in order to accurately track profitability, businesses must understand the many financial KPIs available and what they indicate.
The Importance of KPIs in Business Budgeting and Forecasting
KPIs provide metrics that determine if departments are hitting the necessary benchmarks to maintain profitable operations. Relevant KPIs can include potential sales leads, average sales in a cycle period, and conversion rates. These metrics measure how well the sales processes are performing, allowing teams to make improvements if necessary.
However, the impact of KPIs stretches far beyond sales into forecasting and budgeting departments. With accurate metrics, forecasting software can generate projections for future sales, customer demand, and traffic, allowing teams to prepare processes for optimal performance.
Advanced forecasting software can predict when fluctuations may occur so financial advisors can develop budget plans to minimize expenses, such as lead costs, for larger profit margins.
Without access to relevant KPIs, budgeting and forecasting rely on guesswork to develop plans for internal departments. This could lead to inefficient operations and spending, putting the business at financial risk.
10 Essential Business KPIs
Regardless of the size of a company, KPIs are essential to tracking revenue, profits, and performance. Businesses can also tailor KPIs to generate specific insights, such as-
1. Operating Cash Flow
Operating cash flow (OCF) represents the total amount of capital gained by daily internal operations. This KPI alerts management of whether the business has adequate funds to initiate business expansion efforts or needs to minimize expenses to generate more cash flow.
OCF is calculated by considering elements such as depreciation, inventory expenses, and accounts receivable when updating the net income. When businesses evaluate their OFC, they should cross-examine it with the total capital used to assess if processes can sustain profitability.
2. Current Ratio
The current ratio determines whether a company is able to pay all of their annual financial obligations. This KPI considers the business's incoming and outgoing payment, such as accounts payable and receivable departments. The comparison of revenue spent and generated creates the current ratio.
A healthy current ratio typically ranges from 1.5 to 3, where organizations can meet obligations given their average cash flow. Businesses with a constant current ratio below 1 cannot fund mandatory expenses without generating additional revenue. On the other hand, if the ratio is too high, the business has too many assets and is not investing enough in business expansion efforts.
3. Quick Ratio
Also known as the acid test, the quick ratio shows whether an organization has enough short-term assets to cover upcoming liabilities. While similar to the current ratio, the acid-test gives a more holistic view of a business's overall financial health as it considers liquid assets, such as stock.
Quick Ratio = (Cash + Accounts Receivable + Short-Term Investments) / Current Liabilities
4. Burn Rate
The burn rate represents the spending habits of a business for a set time frame, such as weekly, monthly, quarterly, or annually. This trend determines whether a company's operational costs have longevity. This KPI is especially useful for small businesses that do not require extensive financial analysis.
5. Net Profit Margin
The net profit margin reflects how a company can generate profits compared to revenue. While this KPI is typically shown as a percentage, it indicates how much each dollar of income contributes to their profit. This metric not only shows an organization's profitability but can also help project scalability.
Net Profit Margin = Net Profit / Revenue
6. Gross Profit Margin
Unlike the net profit, the gross profit margin measures the pure capital leftover from revenue after considering the costs of products and services sold. This KPI is an excellent indicator of financial health and determines whether a business has enough capital to invest in expansion ventures after operational expenses.
Gross Profit Margin = Cost of Goods Sold / Revenue
7. Working Capital
The working capital metric determines whether a company has an adequate amount of on-hand assets to satisfy short-term financial obligations. These assets refer to any liquid credits, such as cash, investments, and accounts receivable to demonstrate an organization's ability to quickly generate cash.
A healthy working capital KPI ensures a company has enough capital to account for upcoming liabilities.
Working Capital = Current Assets Current Liabilities
8. Inventory Turnover
The inventory turnover rate determines how efficiently a business sells and replenishes stock during a set time frame. This directly reflects the company's ability to produce sales and promptly replace depleted items.
Businesses can calculate their inventory turnover rate one of two ways-
Inventory Turnover = Sales / Inventory
Inventory Turnover = Cost of Goods Sold / Average Inventory
9. Budget Variance
As KPIs are typically used for project management, budget variance shows how estimated budgets compare to actual budget totals. This measurement determines whether a business's budget planning is accurate and meets the expected revenue and expenses.
A small budget variance shows that the actual expenditures are equal to or lower than initially projected, or the generated revenue is higher than expected. On the other hand, a significant budget variation indicates inaccurate forecasting methods or poor decision-making.
10. Payroll Headcount Ratio
The payroll headcount ratio is a financial KPI that indicates how many employees are involved in payroll processes compared to all workers. In other words, this ratio determines the number of full-time employees to an organization's total number of staff. This metric helps management monitor in-house employee turnover and demand.
Payroll Headcount Ratio = Full-Time Employees / Total Number of Employees
KPIs are a great way to efficiently monitor internal business processes and operations to ensure quality performance. By regulating budgeting and forecasting metrics, businesses can track profitability, sales, revenue, inventory, and expenses. This functionality supports evidence-based decision making to promote business growth.