Key Performance Indicators (KPIs) are critical for any organization to track, as they provide insight into how well the organisation is performing and where improvements can be made. While there are many KPIs that can be tracked, some are more important than others. Here are 5 KPIs that every organization should track:
- Cash burn rate
This is a critical metric for any organisation that is looking to manage its finances effectively. It is a measure of the rate at which an organisation is spending its available cash and helps to determine how much runway (time) the organisation has before it runs out of cash.
Calculating cash burn rate
Step 1: Determine the Period of Time The first step in calculating the cash burn rate is to determine the period for which you want to calculate the rate. This period could be a month, a quarter, or a year. Once you have determined the period, you will need to gather the necessary financial information for that period.
Step 2: Gather the Financial Information The second step is to gather the financial information for the period in question. This information includes the organisation’s total expenses, including salaries, pension contributions, rent, utilities, marketing expenses, and any other costs associated with running the business. You will also need to determine the cash balance at the beginning and end of the period.
Step 3: Calculate the Cash Burn Rate To calculate the cash burn rate, you need to subtract the ending cash balance from the beginning cash balance and divide the result by the number of months in the period. The formula is as follows: (Cash at the Beginning of the Period – Cash at the End of the Period) ÷ Number of Months in the Period = Cash Burn Rate.
- Operating cash flow (OCF)
This is a vital financial metric that measures the amount of cash generated or used by an organisation’s core operations. It is a crucial measure of an organisation’s financial health and cash-generating ability, providing insight into how efficiently an organisation manages its working capital and generates cash from its business activities.
OCF represents the cash generated by an organisation’s core business operations, excluding financing and investing activities. It is calculated by adding back non-cash expenses, such as depreciation and amortization, and adjusting for changes in working capital. The resulting figure indicates the amount of cash generated by an organisation’s operations, which can be used to reinvest in the business, pay down debt, or distribute to shareholders.
A positive OCF indicates that an organisation is generating enough cash from its operations to meet its financial obligations, while a negative OCF indicates that the organisation may be experiencing financial difficulties.
Calculating operating cash flow:
Step 1: Gather the Necessary Financial Information. You will need to gather the income statement, cash flow statement, and balance sheet for the period you want to calculate the operating cash flow.
Step 2: Determine Net Income The second step is to determine the net income for the period. You can find this figure on the income statement.
Step 3: Add Back Non-Cash Expenses The third step is to add back any non-cash expenses to the net income. These expenses include depreciation and amortization, which are not cash expenses but are subtracted from revenue to arrive at net income. This adjustment is necessary to reflect the actual cash generated by the business.
Step 4: Adjust for Changes in Working Capital The fourth step is to adjust for changes in working capital. Working capital is the difference between an organisation’s current assets and current liabilities. If an organisation has positive working capital, it means that it has more short-term assets than short-term liabilities, indicating its ability to meet its short-term obligations. In contrast, negative working capital means that an organisation has more short-term liabilities than short-term assets. Changes in working capital can impact the operating cash flow. Therefore, you need to adjust for changes in working capital to calculate the operating cash flow.
Step 5: Calculate Operating Cash Flow. The final step is to calculate the operating cash flow by adding the adjusted net income to the adjustments for non-cash expenses and changes in working capital. The formula is as follows:
Operating Cash Flow = Net Income + Non-Cash Expenses + Changes in Working Capital
- Working capital ratio
This is a fundamental financial metric used to evaluate an organisation’s short-term liquidity and its ability to meet its current obligations. The ratio is calculated by dividing a organisation’s current assets by its current liabilities. The resulting figure provides an indication of how much working capital an organisation has available to cover its short-term debts. It is a vital financial metric that provides valuable insight into a organisation’s short-term liquidity and ability to meet its current obligations.
Working capital ratio measures an organisation’s efficiency in managing its working capital and generating cash flow from its operations. By tracking and monitoring the working capital ratio, companies can ensure that they have enough liquidity to cover their short-term debts, manage their cash flow effectively, and make informed decisions about their financial health and future growth potential.
Calculating working capital ratio
To calculate the working capital ratio, follow these steps:
Step 1: Identify the current assets of the organisation. These include cash, accounts receivable, inventory, and other assets that can be converted into cash within one year.
Step 2: Identify the current liabilities of the organisation. These include accounts payable, short-term loans, and other debts due within one year.
Step 3: Divide the current assets by the current liabilities to arrive at the working capital ratio.
Working Capital Ratio = Current Assets / Current Liabilities.
A working capital ratio of greater than 1 indicates that the organisation has adequate current assets to cover current liabilities, which demonstrates that the organisation has good liquidity and is well-positioned to meet its short-term financial obligations.
- Operating margin
This is a financial ratio that measures an organisation’s operating income as a percentage of its revenue. It provides insights into an organisation’s viability and/or profitability and operational efficiency by evaluating its core operations’. Operating margin is a critical metric for investors, financial analysts, and the organisation’s management as it helps to compare the positioning in the industry. A higher operating margin indicates better operational efficiency, while a lower operating margin suggests operational inefficiencies.
Calculating operating margin
Step 1: Obtain the organisation’s operating income and revenue figures from its income statement. Operating income is the amount of surplus or profit an organisation generates from its core operations, after deducting all operating expenses such as wages, rent, audit fees and materials.
Step 2: Divide the organisation’s operating income by its revenue and expressing the result as a percentage. Revenue refers to the total amount of money an organisation generates from sales of its goods and/or services, receipt from grants etc. It can be found on the income statement under the “revenue” or “income” section.
A high operating margin is generally seen as a positive sign because it suggests that an organisation is generating a significant amount of profit from its core operations. This could be due to factors such as effective cost management, streamlined production processes, or a strong sales and marketing strategy. A high operating margin also indicates that an organisation has more financial resources available to invest in growth initiatives and/or pay dividends to shareholders.
- Actual vs Plan
This is a crucial key performance indicator (KPI) that enables organisations to measure their performance against their planned goals. This metric helps organisations to assess how effective their planning and execution processes are and provides a clear picture of the organisation’s progress toward achieving its objectives. The Actual vs Plan KPI is typically expressed as a percentage or numerical value, and it can be applied to various areas of an organisation’s performance, such as revenue, expenses, surplus, or production.
By comparing actual results with the planned results, organisations can identify areas of strength or weakness in their processes and strategies. For instance, if an organisation’s actual revenue is lower than planned revenue, it may indicate that the organisation needs to improve its marketing and sales strategies to attract more customers. Similarly, if the actual cost is higher than the planned cost, it may indicate that the organisation needs to improve its cost management strategies. This KPI can be used to assess performance trends and make data-driven decisions to optimize operations.
Conclusion
Key performance indicators (KPIs) are crucial in organisations as they provide a measurable way of tracking progress towards achieving goals and objectives. By monitoring their performance and identifying areas of strengths and weaknesses, organisations can make data-driven decisions to optimize their operations and achieve their objectives. KPIs enable organisations to focus on what matters most and drive continuous improvements. At FH Consulting, we are committed to helping you obtain insights from your operations, contact us for insightful data analytics and industry specific KPIs deployment.
