There are multiple ways to drive improvement in business profitability: reduce cost for the same revenue, enhance revenue for the same cost level, and improve the best unit economics. Whatever may be your objective, you will need to measure and track operational and functional performances using business metrics. The right metrics will provide the businesses with insights into the performances to help understand areas that are doing well and that is not
Business Ratios and Metrics are quantitative measurements applied by companies to identify and analyze performances to enable businesses to analyze and understand how the business is performing. Such metrics are compared against its own expectations standards, benchmarks, industry peer standards, or accepted business yardsticks, or some or all of them.
The ratios and metrics benefit businesses by letting them know the level of their performance in each area and helping identify the problems that are causing problems for the business. Since the metrics are compared with industry and peer standards, it will guide the businesses to take necessary actions to pursue the operations so as to reach the level of the best-performing companies in the industry.
There are numerous business metrics and ratios available for use. While some are generic, some are useful for specific industry segments. The businesses must identify the best suitable measurements for their business – in terms of industry norms and company-specific requirements – in order not to spend time without getting any value from the exercise. Here are some of the popular and widely-used metrics:
Arguably, financial metrics are the most popular and widely used metrics and ratios used in businesses.
These metrics measure liquidity, a test of how fast a company can convert its assets into cash to meet short-term liabilities. The working capital is the difference between the current assets and current liabilities of the company and is an indicator of its capability to pay its current liabilities with its current assets. The working capital ratio, aka, current ratio, is calculated by dividing current assets by current liabilities.
The best ratio for a company depends on many factors such as the type and size of the business and its overall financial health, among others. While a current ratio of 1 is the bare minimum, a ratio above 1 ( meaning current assets are more than that of current liabilities) points to a healthy liquidity position. However, a very high ratio reflects the management for not using short-term assets productively to enhance shareholder value and pay dividends. A ratio lower than 1 is an alarm to the business.
This is a more intense measurement of liquidity and therefore, also called acid ratio. It measures a company’s ability to pay all current liabilities with current assets that can be liquidated quickly. In this measurement, while the current liabilities remain the same as used in the current ratio, the current assets that cannot be quickly converted to cash, such as inventory, and prepaid expenses, are taken out of the current assets. A quick ratio of 1 is considered healthy, but a ratio lower than that is an alert to take care of the cash flow.
This ratio which is calculated by dividing total liabilities by total shareholders’ equity, measures how much-borrowed money (debt) is used to fund the company’s operations and the extent of coverage of debt by shareholder equity when needed. A capital structure with too much debt and as well very little or no debt is not necessarily the best financial management practice. It is important to look at the capital structure from the cost of capital, leverage, and risk angles. This ratio also gives insight into the impact of debt ratio on fixed finance costs and earnings available for dividends.\
EBITDA is one of the most popular profitability metrics used in various business decisions. This is derived by adding back the non-cash depreciation and amortization expense as well as taxes and debt costs, to net income, making it equivalent to the cash profit generated by the company’s operations. However, EBITDA is not a metric recognized under most accounting standards including GAAP and IFRS.
The return on equity metric tells how effective and profitable the shareholder equity is used by the company This net income used for this calculation is the income before paying dividends to common shareholders, but after paying preferred share dividends.
The net profit margin measures how much actual profit a company makes against the revenue it generates. This is an important measurement because revenue increases may not always result in increased profitability. The formula for net profit margin is: Net profit margin = (Net income / Total revenue) x 100
GP Margin considers a company’s profits before deducting expenses, such as interest, taxes, depreciation, amortization, and operating expenses like salaries, rent, utilities, and marketing. It indicates whether a business is generating sufficient gross profit to cover all the expenses of the business. The formula is (Revenue – Cost of goods or services sold) / Revenue).
This ratio measures how effectively the business invoice its customers for the goods or the services delivered and collect payments for the invoices from its customers. A higher ratio indicated the company’s collection process is effective and vice versa. The formula is:
Accounts receivable turnover ratio = Net credit sales in a given period / Average accounts receivable of period
A high percentage of overdue payables means the company has a cash flow problem to settle payments to suppliers and other creditors. This can impact the business in the form of disruptions in supplies and services. A lower percentage means the company is paying its suppliers and creditors on time.
Accounts payable overdue rate = (Accounts payable overdue / Total accounts payable) x 100
Sales metrics are used to evaluate the performance of a salesperson, sales team, or the company as a whole. It provides insights into what actions need to be taken to improve the performance of sales activities and teams. Here are a few key sales metrics businesses must track.
The types of sales revenue metrics to track in a business vary depending on multiple factors, like the business model, revenue and billing model, the industry, regions it operates, and the company and organization structure, among many others. It is calculated by using the formula: Gross sales – Discounts – Returns – Costs associated with discounts and returns
Every company wants to know its year-over-year (YoY) growth, which is an important sign of the overall health of the business. The metric compares the business’s growth rate with industry benchmarks and the company’s previous revenue, to know how well or how badly the sales team is performing. The formula used for calculating the metric is: (Current year revenue – Previous year revenue) / Previous year revenue x 100
The churn rate calculates the percentage of customers who leave or stop doing business with a company. This metric points to a sales team’s ability or inability to retain customers. It is computed by using the formula: Number of customers lost during period / Starting number of customers at beginning of period x 100
Businesses employ various marketing channels, such as email, cold calls, promotions, endorsements, print, visual media advertisements, websites, social media, etc. It is critical to what combination works best by measuring the impact on revenue increase.
Understanding how much it costs to onboard and retains a customer is an important marketing metric that will help in developing marketing strategies. Total marketing spend / Number of new leads is the formula to calculate CPL.
This is one of the most popular marketing measurements that consider all marketing and sales costs including sales team salaries, and benefits to the ad spend. Customer acquisition cost = Total marketing and sales spend / Number of new customers
This metric calculates the total profit earned by the company from a customer over the entire time they remain a customer. This is calculated by applying the formula: (Average transaction value x Average number of transactions in a year x Average customer retention in years) x Profit margin
This brings home the percentage of existing customers who remain during a specific period of time. The formula is: (Number of customers at end of a period – Customers added during the period) / Number of customers at beginning of the period
This is a metric that points to the profits from incremental sales that are contributed by marketing activity. It gives insights into the value each marketing activity generates and as well understands which mix of channels performs well and which don’t. You will get the Return on marketing investment by applying the formula: (Sales growth – Marketing cost) / Marketing Investment x 100
While some marketing and sales metrics like churn rate, customer lifetime value, and customer retention are relevant or specific to SaaS business models, there are other metrics that are used mostly by SaaS companies. Such metrics that can provide actionable insights for SaaS companies include
This is a key metric used by SaaS companies to measure the total of all revenue expected to receive in a month. MRR is calculated by adding the total revenue from paying customers in a given month. This has a few modified versions like New MRR – revenue from new customers -, Expansion MRR – revenue from upgraded customers -, and Churn MRR – revenue lost from lost customers.
Also known as annual revenue per unit (ARPU), this metric measures the average revenue generated by each account.
The formula is: ARPA = MRR / Total number of customers in that month
Human resources metrics and ratios help companies look at talent attritions, their impact on business, and the effectiveness of their recruitment process. And the influence of company culture, and training. Some important HR metrics include:
High attrition rates can reflect on talent management, unhappy workers, or recruiting employees process.
Turnover rate = (Number of separations in a given period / Average number of employees in period) x 100
eNPS measures the probability of an employee recommending their company to others as a place to work, or its products to family or friends. The formula is
eNPS = Percentage of promoters – Percentage of detractors
This metric helps track the ratio of vertical promotions to lateral transfers. The formula is:
Career path ratio = Total promotions / (Total promotions + Total transfers)
Earnings per share (EPS) tracks the profitability of a company to enable investors to use it to gain an understanding of company value, before making an investment in a company.
There are a lot more metrics and ratios that matter to and are used by businesses and functions within an organization. We will touch base few more of them that can be useful for the C-suite, operations teams, and other business departments in manufacturing and other industries.
When ratios are properly understood and the corrective measures applied, they can help businesses improve their performances and results. However, the overall performance of a company cannot be properly evaluated using one ratio in isolation. What is more important is to identify the combination of ratios and metrics that are to be ideally used for a particular company, depending on its industry, size, and ownership form, among others. It is highly difficult for collecting and collating relevant data and calculating and analyzing the metrics manually, you need a simple and easy-to-use analytics platform to help you.
The PACI financial analysis and management tools available on the cloud are built on modern technologies like AI, ML, NLP, RPA, and blockchain technology and will be part of it in the coming days. The current platform frees you from the need to spend innumerable hours understanding and analyzing your cash flows to run the operations, plan future growth, and negotiate with investors.
Paci.ai, a unified finance management platform for SMBs, looks forward to tackling the backwards-looking nature of accounting with its insights and predictor modules.
The insights module works on the concept of proactive messaging on trends ( Income, expenses, customers, and key notifications providing a small business with actionable insights at the right time.
The predictor module ( Coming soon), leverages historical data to simulate key but the day – to day decision-making on hiring, buying capital equipment and planning promotions among others.