Many businesses develop a list of key performance indicators (KPIs) to track profitability and spot issues before they become full-blown problems. Monitoring KPIs is essential because they allow you to keep tabs on what’s happening at the moment and be proactive in running your business, unlike annual financial statements that show you what happened in the past.
There are dozens of potential KPIs to track, but here are a few important ones for businesses, no matter what industry you are in.
Gross Profit Margin
Gross profit margin shows how much profit your business made after paying the direct costs of creating your product or service. It’s usually expressed as a percentage. You calculate gross profit margin with the following formula:
(Net Revenue – Cost of Goods Sold)/Net Revenue x 100% = Gross Profit Margin Ratio
What is a “good” gross profit margin? That depends on your industry. Service industries that don’t sell a physical product generally have higher gross profit margins because they have a much lower cost of goods sold. For example, according to data from NYU’s Stern School of Business, banks typically have gross profit margins close to 100%, whereas auto and truck manufacturers average around 14%.
Using your industry’s average gross profit margin as a baseline can help determine whether your business is charging enough for products and services and managing direct costs well.
Operating Cash Flow Ratio
Your operating cash flow ratio is a measure of liquidity. With cash generated from your core business operations, it looks at how well your company can pay off its current liabilities, such as accounts payable, accrued liabilities, and short-term debt.
The formula for calculating your operating cash flow ratio is:
Cash Flow from Operations / Current Liabilities = Operating Cash Flow Ratio
You can find your cash flow from operations on your statement of cash flows and your current liabilities on your balance sheet.
A healthy cash flow ratio is usually one or above. This means the company can cover 100% of its current liabilities with cash generated from operations. A ratio less than 1 means your business could have liquidity troubles and is in danger of failing to meet its financial obligations.
Profit Per Employee
As your business grows, it can be tough to know when to add staff. One metric to help make that decision is the profit per employee, which is calculated as:
(Total Revenue – Total Expenses) / Total Number of Employees = Profit Per Employee
The ideal profit per employee for your business depends on your industry, the size of your organization, and whether your company is new or established. Rather than looking at benchmarks, consider tracking this KPI monthly to monitor how it changes over time. For example, as employees gain experience, your profit per employee should increase. When you hire new employees, it might temporarily fall as new hires take time to learn their jobs, but you can monitor whether it eventually meets or exceeds your ratio from before.
Customer Acquisition Cost
Customer acquisition cost (CAC) measures the cost of converting a potential lead into a new customer or client. Calculate this metric with the following formula:
Sales and Marketing Expenses / Number of New Customers = Customer Acquisition Cost
Your sales and marketing expenses might include money spent on ads and marketing campaigns, sales and marketing employees and contractors, and marketing automation technology.
Like other metrics, average CACs vary by industry. According to Entrepreneur, in the travel industry, where one online ad might be shown to millions of website visitors, the average CAC is just $7. On the other hand, the average CAC in the financial services industry is $175, where advisors might build personal relationships with potential clients for months or even years.
Customer acquisition cost can be a valuable metric to evaluate how well different sales and marketing tactics convert prospects to clients.
The KPIs outlined above are a good place to start tracking your organization’s profitability and performance. Once you master these, you may wish to incorporate other industry-specific metrics to identify opportunities to improve performance and profitability. Reach out to our team for help setting up these KPIs or building out more specific metrics to track.