It’s easy for business owners and executives to get caught up in the daily tasks of running a company. The time and attention required to maintain operations, drive sales, and propel growth can be significant. Unfortunately, this often leaves little time for other important tasks, such as regularly assessing the organization’s financial vitality and performance. Regular monitoring of financial metrics through key performance indicators (KPIs) provides access to important financial information and trends.
Atlanta businesses can better understand liquidity, solvency, profitability, efficiency, and valuation by analyzing numbers from income statements, cash flow statements, and balance sheets. Out of these metrics, companies may choose a handful of KPIs tied to values indicative of the business’s success. When financial metrics are connected to business goals, it’s easier to see what progress has been made or what improvements need to take priority. To help clients, prospects, and others, Wilson Lewis has summarized the key details below.
Key Financial Metrics
When creating financial reports and deciding on KPIs, consider including the following metrics: profitability, liquidity, solvency, and efficiency.
Profitability Metrics
- Gross Profit Margin: After deducting the direct costs associated with delivering a product or service, the gross profit margin is what’s left. It measures how efficiently a company is turning a profit with its offerings. Higher gross margins mean better pricing strategies and profitability.
- Net Profit Margin: The net profit margin measures a company’s profitability minus all expenses. This includes all operating costs, interest, and tax. Higher net margins mean better business efficiency and financial health.
- Return on Investment (ROI): The goal of ROI is to evaluate the benefit an investment is bringing to the company. Efficiency is assessed by comparing the net profit to the initial cost. Higher ROIs mean the investment in the business has been more successful.
- Earnings Per Share (EPS): This demonstrates a company’s profitability per share. Net income divided by outstanding common shock shares will result in EPS. Higher EPS values generally mean that a business is performing better financially.
Liquidity Metrics
- Current Ratio: How well can a company meet short-term obligations? The current ratio tries to answer this question by dividing the current assets by the current liabilities. If the ratio received is more significant than one, this means that the business can cover immediate debts.
- Quick Ratio: The quick ratio can be a more helpful metric for businesses that have assets that are harder to convert into cash. Also known as the acid-test ratio, the calculation is the same as the current ratio, but the current assets only include liquid assets. The quick ratio can give a more realistic look at what assets (cash or otherwise) can immediately be used to cover debts.
Solvency Metrics
- Debt-to-Equity Ratio: The debt-to-equity ratio is fairly straightforward. It takes the company’s total debt and compares it to shareholder equity. If this ratio is higher, it means that the business carries a higher degree of financial risk.
- Interest Coverage Ratio: While the current and quick ratios demonstrate how well a business can fulfill its debt obligations, the interest coverage ratio shows how well a company can meet interest payments on these debt obligations. The calculation involves taking earnings before interest and taxes (EBIT) and dividing it by interest expenses. If the ratio is higher, it means that the business has a more extraordinary ability to cover interest payments.
Efficiency Metrics
- Inventory Turnover Ratio: Inventory sitting on the shelves does nothing for a company’s earnings, and too much excess inventory can cause long-term adverse financial effects. The inventory turnover ratio divides the cost of goods sold by the average inventory available. Higher turnover ratios typically mean inventory is being managed more effectively.
- Accounts Receivable Turnover Ratio: How quickly do customers pay back the business after an invoice is issued? The accounts receivable turnover ratio divides net credit sales by the average accounts receivable to understand how efficient the payment collection process is. High turnover ratios mean customers are paying more quickly.
- Accounts Payable Turnover Ratio: Similarly, an accounts payable turnover ratio measures how quickly the business pays its vendors by dividing total purchases by average accounts payable. Unlike the high accounts receivable ratio, a high turnover ratio in this category means a business is taking longer to pay suppliers.
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One single metric won’t tell business leaders what they need to know about the health and success of the organization. These key performance indicators, when presented together, can help a business decide which offerings to grow, where efficiencies can be made, and whether other changes need to be made. If you have questions about the information outlined above or need assistance with another accounting or tax issue, Wilson Lewis can help. For additional information, call 770-476-1004 or click here to contact us. We look forward to speaking with you soon.