For small and medium businesses (SMEs), tracking financial Key Performance Indicators (KPIs) provides critical insights into financial health and sustainability, helping businesses make better decisions and achieve long-term success. While there are countless KPIs that businesses can track—spanning operations, marketing, customer satisfaction, and other areas—this piece focuses specifically on financial KPIs.
Here are five financial KPIs that many SMEs find valuable to track, along with their formulas and why they matter. Keep in mind that the right KPIs for your business will depend on your industry, goals, and current challenges.
1. Gross Profit Margin
What It Is: The percentage of revenue that exceeds the cost of goods sold (COGS), showing how efficiently your business generates profit.
Formula: (Revenue – COGS) / Revenue x 100
Example: If your revenue is $100,000 and your COGS is $40,000, your gross profit margin is 60%.
Good Score: Businesses often aim for a gross profit margin of 50% or higher, though this can vary by industry.
Why It’s Important: Assessing your gross profit margin helps you determine whether your pricing and cost control strategies are effective. If the margin declines, it likely indicates rising costs or pricing issues, prompting necessary adjustments. For example, if your margin is 60%, this means you’re keeping 60 cents from every dollar of sales after covering the cost of goods.
2. Current Ratio
What It Is: A measure of your business’s ability to meet short-term obligations with short-term assets.
Formula: Current Assets / Current Liabilities
Good Score: Businesses with a current ratio between 1.5 and 2 typically have enough assets to cover their liabilities comfortably.
Why It’s Important: Calculating the current ratio helps you gauge liquidity and ensure your business can handle financial obligations. Ratios above 1 indicate that assets exceed liabilities, while ratios below 1 might signal cash flow concerns.
3. Net Profit Margin
What It Is: The percentage of revenue left after all expenses, taxes, and interest are deducted.
Formula: Net Profit / Total Revenue x 100
Example: If your revenue is $200,000 and your net profit is $20,000, your net profit margin is 10%.
Good Score: A net profit margin of 10% or higher is considered good for most industries, though it can vary significantly.
Why It’s Important: Examining the net profit margin helps you assess the overall profitability of your business. It shows how much of every dollar earned is kept as profit. This KPI is particularly important for identifying areas where expenses can be reduced to improve overall profitability.
4. Debtor Days
What It Is: A measure of how long, on average, it takes your customers to pay their invoices.
Formula: (Average Accounts Receivable / Total Credit Sales) x Number of Days in Period
Example: If your average accounts receivable is $50,000, total credit sales are $500,000, and the period is 365 days:
(50,000 / 500,000) x 365 = 36.5 days.
Good Score: Debtor days should ideally align with your payment terms, such as 30 days. If debtor days are longer, this might indicate inefficiencies in the collection process or customer payment issues.
Why It’s Important: Monitoring debtor days measures how efficiently your business collects payments and manages cash flow. Lower debtor days suggest prompt payments, ensuring healthy cash flow, while higher debtor days might point to delays that could strain your finances.
5. Debt-to-Equity Ratio
What It Is: A measure of your business’s financial leverage, showing the proportion of debt to equity used to finance your operations.
Formula: Total Liabilities / Total Equity
Good Score: For many SMEs, a debt-to-equity ratio of 1 to 1.5 is considered healthy. A higher ratio might indicate over-reliance on debt, while a lower ratio suggests conservative financial management.
Why It’s Important: Use this KPI to determine how much your business relies on debt compared to equity. Monitoring this KPI helps you balance growth opportunities with financial stability.
Final Thoughts
These five KPIs are practical tools to help you monitor and manage your business’s financial performance. However, every business is unique, and the right KPIs will depend on your specific circumstances and goals.
In addition to these, other KPIs—like inventory turnover or customer acquisition cost—might be valuable depending on your business focus. For further information and resources, check out this guide from Business Queensland: Understanding and Setting KPIs.
If you’re unsure which KPIs to focus on or need assistance implementing tracking systems, partnering with a trusted advisor like POD Business Solutions can help. We’re here to support SMEs in gaining financial clarity and making informed decisions.