The financial planning and analysis process creates goals and translates them into actionable financial plans. As part of the process management and performance reporting is conducted to ensure that the plans and budgets created are being followed and executed successfully.

Financial analysts rely on key performance indicators, or KPIs, to assist them in measuring the effectiveness of the organization in reaching these goals. 

Financial KPIs are not limited to management and performance reporting. They are used throughout corporate finance to provide context by which to measure performance.

In this FAQ, we will cover what financial KPIs are, why they are important, and some of the more commonly used financial KPIs.

What Is A Financial KPI?

A financial KPI is a financial metric that provides a quantifiable value by which to measure a business’s financial results and performance against.

They can be used to provide relevant information regarding sales, expenses, profit, cash flow, and financial health. This information is then used to make decisions on how to better optimize a business’s operations to reach its financial targets. 

One of the primary functions of corporate finance is to monitor and analyze the performance of a business. In doing this, analysts require some form of measurement to gauge whether the business is operating well or has a need for improvement. 

Furthermore, analysts require some form of context to measure the business against the overall industry that it operates within. Financial KPIs help to not only provide context for analysts but also guide them in understanding how the business is performing relative to its goals.

Why Financial KPIs Are Important

Financial KPIs are important because they help keep the organization aligned around the goals and objectives. Among the various uses of financial KPIs, perhaps one of the most important functions is that they help keep the business objectives the primary focus when making decisions.

That is to say, they serve as a guide for the decision-making process.

In addition, financial KPIs are a critical component of corporate performance management (CPM). The CPM process of monitoring results requires some form of relevant metric to compare actual results to. Financial KPIs provide these targets and help to ensure that the performance of the organization achieves the targets established. 

Financial KPIs convey relevant information that can be used to correct business activities when they are deviating from the plan or can indicate when adjustments might be required to forecasts.

In certain cases, the business operations might not be suffering but some change in the business environment is having an adverse impact on the organization. 

In these cases, financial KPIs help to illuminate problems that arise from external forces. In this way, the metrics are relied upon to assist in making pertinent adjustments to the financial plans and budgets when necessary.

Another benefit of implementing relevant financial KPIs is that they serve to provide employees and staff with a personal target. When achieved this can have profound impacts on morale and provide a sense of ownership that helps strengthen accountability. 

Finally, relevant financial KPIs help to highlight how the business is performing against the industry it operates within. This helps to establish realistic goals and to serve as a means to meaningfully measure the business against its competitors.

For example, if gross profit margin is a certain percentage across the industry as a whole, the business should strive to achieve that average or better.

Relevant Financial KPIs And How To Calculate Them

While this list is not comprehensive, it should serve as a guide of relevant financial KPIs that are often used. 

Income Related KPIs

  • Gross Profit Margin = (total revenue – COGS) / total revenue
  • Operating Profit Margin = operating income / sales revenue
  • Operating Expense Ratio = (operating expense – depreciation) / gross operating income
  • Net Profit Margin = net profit / total revenue x 100

Liquidity Related KPIs

  • Working Capital = current assets – current liabilities 
  • Current Ratio = current assets / current liabilities 
  • Quick Ratio (Acid Test) = (current assets – inventory) / current liabilities
  • Cash Conversion Cycle = days inventory outstanding + days sales outstanding – days payables outstanding
  • AP Turnover = net credit purchases / average accounts payable
  • AR Turnover = net credit sales / average accounts receivable

Financing KPIs

  • Return on Assets (ROA) = net income / total assets
  • Return on Equity (ROE) = net income / shareholder’s equity
  • Economic value added (EVA) = NOPAT – (WACC x capital invested)
    • Where NOPAT = Net Operating Profits After tax, and
    • WACC = Weighted Average Cost of Capital, and
    • Capital Invested = equity + long-term debt at the beginning of the period, and
    • (WACC x capital invested) is also referred to as “finance charge”)

Using Datarails, a Budgeting and Forecasting Solution

Datarails’ FP&A software replaces spreadsheets with real-time data and integrates fragmented workbooks and data sources into one centralized location. This allows users to work in the comfort of Microsoft Excel with the support of a much more sophisticated data management system at their disposal. 

Every finance department knows how tedious building a budget and forecast can be. Integrating cash flow forecasts with real-time data and up-to-date budgets is a powerful tool that makes forecasting cash easier, more efficient, and shifts the focus to cash analytics. 

Regardless of the budgeting approach your organization adopts, it requires big data to ensure accuracy, timely execution, and of course, monitoring.

Datarails is an enhanced data management tool that can help your team create and monitor cash flow against budgets faster and more accurately than ever before.