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If you want to manage and grow your business and reach your goals, it’s essential to track various metrics that reveal its current health. One of the biggest problems is that there are so many potential numbers you could monitor, so how do you know which ones are the most important for your business?
Plus, if you’re in the weeds of growing your business, you’re likely still responsible for managing many different aspects of your business, and creating time to analyze metrics can fail to make your list of priorities. Enter KPIs (Key Performance Indicators). The right KPIs will help you track and move forward in your business without bogging you down with too many details and prevent burnout.
In this article, I’ll answer:
- What are KPIs in business?
- Critical KPIs your business should track
- Choosing the right KPIs for your business
What is a KPI in business and why are metrics important?
A KPI is a metric that businesses use to determine the health of their business and progress towards their short and long-term goals. KPIs can help you make important decisions, keep you on track, know when you’re veering off course, and show you whether your day-to-day actions lead to desired results. Another key benefit of tracking specific KPIs is to help you identify weaknesses early on in your business so that you can fix these before they swell into bigger, more critical problems.
There are three main types of KPIs:
- Financial KPIs
- Customer KPIs
- Process KPIs
Across these three types of KPIs are two different types, which I refer to as macro KPIs and micro KPIs.
Macro KPIs are company-driven metrics, while micro KPIs are driven by individual employees, which vary between roles.
Many business owners come to me for help in scaling their business, and one of the common mistakes I see them making is not knowing their numbers. If you want to scale your business, you must know your numbers yourself or have people around you who give you reliable data. Too many advisors and bookkeepers are unsure what data to provide business owners with or provide incorrect data.
Critical KPIs your business should track
Here are some critical KPIs your business should track to help you manage your business, obtain benchmark data to compare with competitors in your industry and gauge whether you’re improving the overall value of your business.
1. Net profit
The first KPI your business should track is net profit over time. This figure won’t necessarily always go up. For example, there will inevitably be periods when you’re investing more heavily in growing or scaling, or economic challenges affect sales and profits. But keeping track of this metric will show you, on the whole, whether your business is becoming more or less profitable each year and whether it is making more money than it’s spending.
How to calculate it: Net profit = revenue – expenses
2. Gross profit margin
The gross profit margin will indicate how much money your business is left with after paying to produce and package the product or service you have sold. The higher your gross profit margin, the more money your business has to pay for other expenses, including employee or freelancer wages, rent, and marketing.
How to calculate it: Gross profit margin = (sales – costs of goods & services) / total sales x 100
This can be calculated for each product or service or as a total for your business.
3. Cash flow forecast
Cash flow forecast is another one of the critical KPIs your business should track because it tells you how much cash is flowing in and out of your business. Good cash flow is vital, especially if operating on small margins.
Your business can quickly go bankrupt without a healthy cash flow, even if there’s still a healthy demand for your products or services. For example, if your rent is due on the 1st of every month, and you send a series of invoices out in the previous month and are counting on that money to pay your employees, you can end up in difficulty if one of your clients doesn’t pay you on time. Keeping track of your cash flow forecast can prevent disasters like this by ensuring you always know how much cash you have on hand.
How to calculate it: Cash flow forecast = (beginning cash + projected inflows) – projected outflows
4. Net profit margin
Net profit margin is a KPI used to indicate how profitable your business is at any given time. This will show you how well your revenue is currently being used and how much profit you earn from the money you take in.
Do you know how much your business retains for every $1 it earns? The net profit metric will tell you. Comparing your net profit margin from one year to the next will show you if an increase in revenue leads to a rise in profit at the same rate.
How to calculate it: Net profit margin = (net profit ÷ revenue) x 100
5. Conversion rate
Conversion rate is a critical KPI to track in your business because it tells you how many prospects turn into actual customers. This gives you a better understanding of how successful your current marketing efforts are and whether they need adjusting. Over time, you can track how changes to your sales and marketing affect your conversion rate and continue to tweak your strategies accordingly.
How to calculate it: Conversion rate can be calculated in different ways depending on the type of business you have.
An online store could determine its conversion rate by doing the following sum: (Number of purchases / number of unique visitors) x 100
Important KPIs your business should track
Here are some critical KPIs your business should track to help you manage your business, obtain benchmark data to compare with competitors in your industry and gauge whether you’re improving the overall value of your business.
1. Gross profit
Gross profit measures the revenue your business generates after taking away the cost of producing your products or services. First, you’ll need to calculate your revenue and the cost of your goods.
This is an important KPI to track because, although making a loss in the early years of your business may be part of your business plan, if you go without making a profit for too long, you run the risk of being forced to shut your doors.
How to calculate it: Gross profit = revenue – cost of goods sold
2. Customer acquisition cost
How much does it cost you to gain a new customer or a client for your business? In the early stages, this number may be higher than you’d like it to be, with the expectation that this will lower as your business gains traction and grows, hence why this is an important KPI to track.
How to calculate it: Customer acquisition cost = (sales expenses + marketing expenses) ÷ number of new customers
3. Customer retention rate
Do you know how many of your customers or clients are bringing you repeat business and continuing to come back to buy your products and services? Acquiring one customer is far more costly than retaining an existing one, so this metric is important to track. When customers and clients continue to return, you’re doing something right. If they’re not, something needs to change.
How to calculate it: Customer retention rate = (customers at end of period – new customers acquired during period) / customers at start of period x 100
4. Revenue growth rate
Revenue growth rate is another important KPI for businesses to track because it shows you whether your revenue is growing or shrinking over time. This can be measured between weeks, quarters, years, and even decades, but it’s typically tracked from month to month. The higher your revenue growth rate, the faster your business is growing.
How to calculate it: Revenue growth rate = (period 2 revenue – period 1 revenue) / period 1 revenue x 100
5. Client or customer satisfaction
Happy customers and clients are fundamental to the success and growth of any business. Deliver a fantastic product or service and exceed their expectations, and they’re likely to turn into repeat customers and contribute to word of mouth marketing for your business.
So, how do you know how satisfied your clients or customers are?
You ask them!
You measure client or customer satisfaction.
Tracking this metric over time helps you see how happy your customers are, whether they’re getting happier, or if there are any issues you need to address.
How to calculate it: Send customers or clients a satisfaction survey to determine how satisfied they are with your products or services. This is usually done by using a numerical scale ranging from extremely satisfied to extremely dissatisfied and tracking this score over time.
Other KPIs you might want to track in your business
These KPIs aren’t critical to measure, but you may want to track them depending on the type of business you run.
Efficiency ratio
The efficiency ratio (also known as the cost-to-revenue ratio) tracks how efficiently your business uses its assets to generate revenue. There isn’t one specific formula to measure this as there are different types of efficiency ratios, including fixed asset turnover, inventory turnover, and working capital turnover.
How to calculate it:
Working capital turnover = net sales / average working capital
Fixed asset turnover = net sales / average fixed assets
Inventory turnover = sales / inventory
Quick ratio
Quick ratio helps you see whether your accounts receivable (your current cash, securities, and money expected to hit your account soon) are enough to cover your liabilities. A quick ratio of 1 or more means that your business has enough cash and liquid assets to cover all outstanding bills. Anything lower than 1 means you may struggle.
How to calculate it: Quick ratio = (cash + marketable securities + accounts receivable) / current liabilities
Accounts payable rate
Your business has a unique set of suppliers, manufacturers, and staff to create and deliver your products and services. The accounts payable rate tracks how many transactions you’ve made over a period of time and how much you have spent.
How to calculate it: Monitor your quarterly overhead costs (suppliers, manufacturers, and staff) and the costs per transaction in each month.
Lifetime value of a customer
How much is a customer or client worth to your business? The lifetime value metric is important to know and track because it helps you decide how large of a budget you can have to spend on sales and marketing to attract new customers and clients. For example, if your average customer spends $50 with your business, your customer acquisition costs need to be far less.
This KPI can be tricky to work out depending on the type of business you run. For example, if all your clients are on a retainer model, this KPI is easy to measure, but it becomes more challenging if you work with clients on a project basis.
How to calculate it:
Lifetime value of client = average number of projects with client x average cost of each project
Lifetime value of a customer = average number of sales with customer x average cost of each sale
Choosing the right KPIs for your business
- Select between 5-10 business KPIs to track, and set up a dashboard or scorecard that you regularly review.
- Select your KPIs according to your industry, the stage of growth your business is in, and your goals for the future.
- Look at both lagging (backward-looking) and leading (forward-looking) indicators.
Ready to track KPIs in your business?
Tracking the right KPIs is fundamental to the health and long-term success of your business. Choose the right KPIs and utilize tools to monitor them, and you will be able to correct weaknesses early on and make evidence-based decisions to grow your business. This is also essential to effectively lead your team and give them a clear numerical goal to work towards each day.
KPIs, key metrics, and scorecards are core items for scaling any business—click here to get a free roadmap to scaling your business today.
