What are financial metrics and KPIs?

Financial metrics are easy to ignore when you're busy shipping, creating, and hustling. But here's the thing: the numbers tell a story; your story.

These metrics reveal the hidden patterns in your business, the subtle signals of growth, and the whispers of potential trouble brewing beneath the surface.

Are you genuinely profitable or mistaking cashflow for something more sustainable? Is that new product line a rocket ship, or is it quietly draining resources?

The MetLife & U.S. Chamber of Commerce Small Business Index (Q1 2024) shows that most small businesses (71%) feel optimistic about the future.

However, over a quarter (28%) remain concerned about their vulnerability to unforeseen events.

The truth is, hope isn't a strategy. And while valuable, gut feelings shouldn't solely drive your decisions.

‍Financial metrics provide the clarity and confidence to make bold moves, course-correct when needed, and build a business that's surviving and thriving.

What is a financial metric?

Financial metrics are quantifiable measures to evaluate and assess a business's performance, health, and stability. They come from a company's financial statements – the balance sheet, income statement, and cashflow statement.

Now, not all metrics are created equal. KPIs (key performance indicators) are a subset of financial metrics critical for tracking progress toward your specific business goals. They're the key indicators that tell you at a glance whether you're on track to achieve your goals.

The terms "financial metrics" and "financial KPIs" are sometimes used interchangeably.

However, understanding the distinction between the two can help you focus on your business's data points.

Why should you use financial metrics?

Measuring performance by using financial metrics is fundamental for business success. These metrics allow you to capitalize on profitable areas while minimizing losses by addressing underperforming sections as soon as possible.

But it's not about tracking every single number. The key to the effective use of financial KPIs is understanding the end goal – the level, output, or figure being aimed at by any department.

It's about understanding and selecting the most effective, relevant, and specific metrics that provide the best insights into your company's performance.

Think of it this way: financial performance metrics are your business journey's compass and fuel gauge. They tell you if:

• You're heading in the right direction. Metrics like revenue growth and profit margins reveal whether your strategies are paying off or need adjustments
• You have enough fuel to reach your destination. Cashflow and working capital metrics indicate your financial runway and ability to meet short-term obligations

These are the KPIs that determine whether or not a company is profitable, sustainable, or at risk.

Companies should decide how often these metrics are measured to deliver the necessary information.

How to use financial metrics

Organizations use metrics and KPIs to analyze their financial status and track their growth (or lack thereof).

Metrics can help to identify any issues preventing them from achieving their goals, giving management two choices: solve the problems or adjust the goals to make them more realistic. 

No single financial KPI is universally applicable to – and helpful for – every business. Some companies may look at profitability or valuation, whereas others may track return on sales or turnover.

Each company will have different KPIs to prioritize.

The financial KPIs a business considers will depend on:

• Business model: your industry, target market, and revenue streams all play a role
• Operational structure: how you manage resources, production, and distribution impacts which metrics matter most
• Business age: startups and established companies have different priorities and challenges
• Strategic goals: your desired outcomes, whether growth, profitability, or market dominance, dictate your focus
• Stage of development: early-stage companies track different metrics than those preparing for an IPO

While the specific KPIs vary, effective financial metrics share these common elements:

• Measurable figure: a quantifiable data point tracked consistently over time (e.g., monthly revenue)
• Benchmark: a starting point for comparison, often including historical data to assess progress and trends
• Target: a predefined goal to strive for, allowing you to evaluate performance at regular intervals
• Review period: a specific timeframe (e.g., quarterly, annually) to analyze results and make necessary adjustments

Categories of financial metrics 

Financial performance metrics can fall into one of a few categories, which help businesses identify the different areas they should be measuring. Common categories of financial KPIs include:

1. Revenue metrics

Revenue metrics track all the money flowing into your business within a specific period – monthly, quarterly, or annually. They paint a clear picture of your sales performance and overall revenue generation.

Examples of financial metrics for revenue: total revenue, net revenue, sales growth rate, average revenue per user (ARPU), return on equity (ROE), and return on assets (ROA)

2. Profitability metrics

Profitability metrics go beyond top-line revenue to reveal how much profit your business generates after accounting for all expenses.

Examples of financial metrics for profitability: gross profit, gross profit margin, net profit, net profit margin, operating profit margin, profit and loss statement, return on sales, and burn rate (for startups)

3. Cost metrics

Cost metrics track all the money flowing out of your business, including direct costs associated with producing your goods or services and indirect overhead expenses.

Examples of financial metrics for cost: cost of goods sold (COGS), operating expenses, and overhead costs

4. Liquidity/capital metrics

These metrics focus on your business's cashflow – the lifeblood of any company.

They assess your ability to meet short-term financial obligations, such as paying suppliers and covering operational expenses.

Examples of financial metrics for liquidity/capital: working capital, current cash ratio, quick ratio, cash conversion cycle, accounts receivable turnover, accounts payable turnover, cashflow available for debt service, and operating cashflow ratio

Learn more: unlocking liquidity – how international small and medium-sized businesses can navigate high demand periods.

5. Solvency metrics

Solvency metrics measure your company's long-term financial stability and ability to meet long-term debt obligations.

They're crucial for securing loans, attracting investors, and ensuring the long-term sustainability of your business.

Examples of financial metrics for solvency: debt-to-equity ratio, debt-to-asset ratio, times interest earned ratio

Key financial metrics

Now that you understand the different categories of financial metrics let's roll up our sleeves and dive into some of the most important ones for small and medium-sized businesses. 

We'll explore two of each category mentioned, how to calculate them, interpret the results, and use them to make strategic decisions that drive growth and profitability.

But remember, these are just a starting point. The specific financial KPIs you prioritize will depend on your industry, business stage, and goals.

1. Total revenue

Total revenue represents the total income generated from your company's operations within a specific period. It encompasses all sales of goods or services, providing a comprehensive view of your revenue streams.

• Calculation: sum of all sales revenue generated during the period
• Example: if your business generated $50,000 in product sales and $20,000 in service sales during a month, your total revenue would be $70,000

Tracking total revenue over time is crucial for identifying trends, seasonality, and the impact of your sales and marketing actions.

For example, a steady increase in total revenue might indicate a successful marketing campaign, while a sudden drop could signal a problem with your product or pricing strategy.

2. Sales growth rate

The sales growth rate measures the percentage increase or decrease in sales revenue over a specific period, typically compared to the same period in the previous year.

This financial performance metric provides valuable insights into the pace of your business expansion and your ability to capture market share.

• Calculation: [(current period revenue - previous period revenue) / previous period revenue] x 100
• Example: if your revenue in the current quarter is $100,000 and in the same quarter last year was $80,000, your sales growth rate would be [(100,000 - 80,000) / 80,000] x 100 = 25%

A positive sales growth rate indicates your business is expanding, while a negative rate suggests a contraction.

3. Gross profit margin

The gross profit margin is a crucial indicator of your company's pricing power and production efficiency. It reveals the percentage of revenue remaining after deducting the direct costs of producing your goods or services (cost of goods sold).

Calculation: [(revenue - cost of goods sold) / revenue] x 100

Example: If your revenue is $100,000 and your cost of goods sold is $60,000, your gross profit margin would be [(100,000 - 60,000) / 100,000] x 100 = 40%

A higher gross profit margin may indicate that you manage your production costs and price your products or services competitively.

4. Net profit margin

Net profit margin is the ultimate measure of your company's overall profitability. It represents the percentage of revenue remaining after deducting all operating expenses, including the cost of goods sold, administrative fees, and taxes.

• Calculation: (net income / revenue) x 100
• Example: if your net income is $20,000 and your revenue is $100,000, your net profit margin would be (20,000 / 100,000) x 100 = 20%

A healthy net profit margin indicates that your business generates sufficient profit to cover all expenses and reinvest in growth.

5. Cost of goods sold

The cost of goods sold represents the direct costs of producing a company's goods or services.

These costs include raw materials, direct labor, and manufacturing overhead.

• Calculation: beginning inventory + purchases - ending inventory
• Example: if your beginning inventory was $10,000, you purchased $25,000 worth of goods, and your ending inventory is $5,000, your COGS would be $10,000 + $25,000 - $5,000 = $30,000

Tracking COGS is essential for determining gross profit and understanding how a company produces its products or delivers its services.

6. Operating expenses

Operating expenses encompass all the costs incurred in running a business's day-to-day operations, excluding COGS and interest payments on debt.

Companies often categorize these expenses as selling, general, and administrative expenses (SG&A).

• Calculation: sum of all operating expenses (rent, salaries, utilities, marketing, etc.)
• Example: if your monthly rent is $2,000, salaries total $10,000, utilities are $500, and marketing expenses are $1,500, your total operating expenses would be $2,000 + $10,000 + $500 + $1,500 = $14,000

Managing operating expenses is crucial for maintaining profitability and ensuring the long-term sustainability of a business.

7. Working capital

Working capital measures your company's ability to meet its short-term financial obligations using its current assets – assets convertible to cash within one year. It provides a snapshot of your company's short-term financial health and ability to manage day-to-day operations smoothly.

• Calculation: current assets - current liabilities
• Example: if your current assets are $50,000 and your current liabilities are $30,000, your working capital would be $50,000 - $30,000 = $20,000

A positive working capital balance indicates that your company has enough liquid assets to cover its short-term debts. It reduces the risk of cashflow problems and ensures operational stability.

To understand your company's liquidity and long-term stability, you need to project your cashflow into the future. Learn more about the importance of cashflow forecasting.

8. Current ratio

The current ratio is another liquidity metric that assesses your company's ability to pay off its current liabilities with its current assets. It provides a quick and easy way to gauge your company's short-term liquidity position.

• Calculation: current assets / current liabilities
• Example: if your current assets are $60,000 and your current liabilities are $30,000, your current ratio would be $60,000 / $30,000 = 2

A ratio of 2:1 or higher is healthy, indicating that your company has sufficient current assets to cover its short-term liabilities comfortably.

9. Debt-to-equity ratio

The debt-to-equity ratio is a key indicator of a company's financial leverage and risk. It measures the proportion of a company's financing from debt compared to equity. 

A higher debt-to-equity ratio indicates that the company relies more on borrowed funds to finance its operations, which can increase financial risk if earnings decline.

• Calculation: total debt / shareholder equity
• Example: if your total debt is $40,000 and your shareholder equity is $60,000, your debt-to-equity ratio would be $40,000 / $60,000 = 0.67

A lower debt-to-equity ratio is more favorable, suggesting that the company is less reliant on debt financing and has a stronger equity base.

10. Times interest earned ratio

The times interest earned ratio measures a company's ability to meet its interest expense obligations on its outstanding debt. It reflects the company's ability to generate enough earnings to cover its interest payments, providing insight into its debt service capacity.

• Calculation: earnings before interest and taxes (EBIT) / interest expense
• Example: if your EBIT is $30,000 and your interest expense is $6,000, your times interest earned ratio would be $30,000 / $6,000 = 5

A higher times interest earned ratio indicates a greater ability to service debt, making the company less risky for lenders and investors. Read more about debt financing: examples, advantages, and types.

Financial metrics example

Now, look at how a business may choose its financial KPIs and execute a strategy to maximize the benefits of each.

After a disappointing quarter of results, ABC Exporter Ltd. reassesses its financial performance measures. The business needs to identify where it's meeting its targets and where it's underperforming.

First, ABC Exporter considers the factors contributing to its underperformance in the previous financial quarter:

• High loan repayment fees: borrowing to cover material costs had burdened the company with significant interest expenses, eating into its profits
• Inefficient accounts receivable: delays in collecting payments from customers were hindering its cashflow and limiting its ability to reinvest in growth

Rather than getting lost in a sea of numbers, ABC Exporter Ltd. focused on the key financial metrics that addressed its pain points:

• Working capital: to manage its cashflow challenges and reduce reliance on costly loans, it prioritized tracking and improving its working capital
• Pricing and profits: to boost the bottom line, it scrutinized its pricing structure and analyzed profitability metrics, including gross profit margin and net profit margin

ABC Exporter Ltd. understood that achieving its goals required a team effort, so it assigned ownership of these metrics to relevant departments:

• Sales manager: tasked with revisiting the pricing structure to ensure profitability without compromising competitiveness
• Finance department: responsible for monitoring working capital and overall profitability, implementing strategies to improve both

The company also set clear, measurable targets:

• Working capital target: $100,000
• Net profit target: 30% increase

ABC Exporter Ltd. is committed to a disciplined approach of regularly reviewing its chosen metrics. Quarterly reviews allowed the organization to track progress, identify potential roadblocks, and adjust its strategies.

Annual reviews provided a comprehensive overview of the performance against its targets. Most importantly, ABC Exporter Ltd. didn't just track metrics; it took decisive action based on the insights gained:

• Invoice factoring: by partnering with an invoice factoring provider, the ABC Exporter freed up cashflow from outstanding invoices
• Pricing optimization: the company adjusted its pricing structure to improve profitability while avoiding a negative impact on sales volume

By embracing this data-driven approach, ABC Exporter Ltd. can achieve a remarkable financial turnaround within a year. It can hit ambitious targets and establish a long-term financial health and growth framework.

How to choose the right financial metrics and KPIs

The example you've just read outlines how a business can identify and align its goals with specific financial targets and tracking mechanisms. It's a powerful blueprint for choosing the right KPIs. Now, let's solidify your understanding with an approach to help you decide on the right financial performance metrics.

1. Strategic alignment

Start with the big picture. What are your company's overarching strategic goals for the next year? Three years? Five years? Are you focused on growth, profitability, market share expansion, or something else?

Break down these high-level goals into smaller, more manageable objectives for different departments or teams. For example, if your goal is to increase market share, your marketing team might focus on brand awareness campaigns while your sales team targets new customer acquisition.

2. Financial KPIs selection

Choose metrics that matter. With your goals defined, you can now identify the key performance indicators that will provide the most meaningful insights into your progress. 

You can refer back to the categories and key metrics we discussed earlier as a starting point.

Choose the ones that reflect the success of your specific goals.

3. Target setting

Establish specific, measurable, achievable, relevant, and time-bound targets (SMART goals) for each financial KPI you select. These goals will give you clear benchmarks to strive for and make it easier to track progress.

4. Tracking and analysis

Determine how you'll track and measure your KPIs. Will you rely on spreadsheets, accounting software, CRM systems, or a combination of tools? 

Once you have a system, set a schedule for reviewing your KPIs. It might be weekly, monthly, quarterly, or annually, depending on the specific metric and your business needs. 

Finally, don't just collect data – analyze it.

Look for trends, patterns, and anomalies that can provide insights into your business's performance and guide your decision-making.

Data-driven and funded: your next move starts now

The numbers don't lie. They strip away the illusions, the assumptions, the gut feelings that can lead us astray.

By mastering the language of financial metrics, you gain access to a deeper truth about your business – a truth that empowers you to make smarter decisions, seize opportunities, and build something sustainable.

But sometimes, even with crystal-clear financials, you need a boost to seize that next opportunity.

That's where Stenn steps in, not with dusty old bank loans but with funding alternatives built for the speed of your business.

Do you have a pile of unpaid invoices slowing you down? Unlock that cashflow with invoice financing. Or are you sitting on a mountain of future revenue potential? Turn it into fuel for growth with revenue-based financing. 

Whatever your story, Stenn's got the plot twist you need. We're talking fast, flexible funding without the traditional banking drama.

What could you achieve if capital wasn't holding you back? 

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