Once you gather the courage and resources to start your own business, it's easy to get into the groove and lose sight of the big picture. To make sure you protect your investment and keep your business on the right track, you need to pay attention to KPIs.
What are They, and What do They Mean?
Key Performance Indicators (KPIs) are an excellent way to measure the health and success of your business. They are measurable values that indicate how well you are meeting your business objectives. Did you set goals for yourself and your team? How do you know whether you hit your targets? KPIs can give you that answer.
There are many measures to consider, but here are five important ones that small businesses can find helpful:
One important measure is the money coming in. How much did you sell? Did you gain ground over last year? How much? One measure is a percentage of increase. To figure that out, follow this procedure with this simple example:
2019 Sales $5000 - 2018 Sales $3000 = Increase $2000
Then, take the increase divided by 2018 Sales (2000/3000 = .66), and you'll see what percentage you increased from the previous year. In this example, the sales increased 66 % over the previous year.
Armed with these formulas, you can then measure your Revenue increase year to year to year.
Percentage of Profit
Now that we see how much your Sales (top line) are increasing, is your profit (bottom line) increasing as well? It doesn't do you any good to have an extra $100,000 in sales if your profit is down from the year before. Are those additional sales costing you more? Then what's the point? Here is an example:
Now divide profit by total sales (1000 by 5000), and you will see that in this example, profit is 20% of revenue. Along with watching your revenue increase year to year, you'd like to see your profit percentage increase as well.
Do you have multiple streams of income? Which one is the most profitable? The easiest example to explain this would be a contractor who does Residential work as well as Commercial work. Which one makes the most money? If you tag both your income and expenses to either one (in Quickbooks, it's called Class Tracking), then you'll be able to determine Profit or Loss for each income stream. If one is highly profitable, let's do more of that! If another one is not, then let's examine why, or stop doing that.
Net profit is another great way to measure the profitability of your business. Net profit is also sometimes called the bottom line, since it is the number found right at the bottom of a company’s balance sheet. Net income is the amount of revenue left over after deducting everything: expenses, cash flow, and costs.
Net Profit Margin
Simply put, there are so many different ways to measure profit because there are many different perspectives that you can look from. Net profit margin is similar to net income, but it is represented as a percentage of revenue. It shows the ratio of net profit to revenue and can help a business understand its level or profitability.
Days Sales Outstanding (DSO)
Days sales outstanding, or DSO, is an important KPI to evaluate when it comes to your company’s cash flow and accounts receivable. It consists of an average of the amount of days it takes for customers to pay you after a sale being made. This KPI is only important or applicable to your business if you conduct credit sales. It’s essential to evaluate and understand, because it can be an early warning sign of cash flow issues. If your DSO is high or seems to be steadily increasing, this can be a sign of cash flow problems or even customer dissatisfaction.
A conversion rate represents the amount of an audience, whether it is visitors to a website or people who clicked on an ad, that actually follow through with a purchase. If there is a high conversion rate, this is indicative that marketing efforts were successful. Conversion rates are especially important to evaluate the success of your marketing and its return on investment.
Customer Acquisition Cost
Customer acquisition costs looks at the amount it costs to acquire a customer. How can this be quantified? CAC is calculated by taking the total amount spent on acquiring customer (usually, theses are considered the marketing costs of your business) and divides it by the number of new customers acquired during the same period of time that the money was spent. This is another important metric to help you evaluate your marketing efforts. However, there are some instances where the return on investment may be seen later, such as investments in SEO.
Any good business owner knows that it's not the money you make on paper that pays the bills. It's what's in the bank. Is your business creating enough cash to cover your expenses? To be sure, you can measure your Cash Flow. Simply defined, it is cash generated by your Operations plus any Cash you receive from Loans or Investments LESS Cash out for your Operating expenses and Loan or Equity payments. Is there anything left over? Good! This is another valuable tool to measure year over year.
This goes right along with Cash Flow. If it's not in your bank account, you can't spend it. What is the status of your Accounts Receivable? Are many of your customer's slow payers? What kind of terms do you offer? Ideally, you want short terms and clients that pay on time. One way to measure this is Days Sales Outstanding. To calculate DSO, divide the total of Accounts Receivable in a period by the total Sales times the number of days in the period. For example:
Total Accounts Receivable = $35,000
Total Sales for the year = $100,000
35000/100000 = .35 X 365 (days in a year) = 128 days
In this example, you have 128 days worth of sales that have not been collected yet.
Obviously, you'd like this number to be smaller. How do you get more money from your clients and into your bank? A good AR management system helps with that.
InvoiceSherpa automates the entire process from sending the invoice, securing the payment, and thanking your customers when the payment is received. You can even program customizable templates to send gentle (or stern) reminders when an invoice is past due.
There are plenty of other KPIs you can consider. Some may be more valuable to your specific business than others. Begin with these basic ones, then add on others that make sense to you. Information is power. The more you know about your business, the better decisions you can make.