Improving sales and increasing turnover is one thing but we think there are 7 financial KPIs for businesses that every Managing Director needs to know.
And these benchmarks need reviewing monthly rather than through a rearview mirror. We all know that if you’re not paying attention to what’s in front of your car, it will likely end in a major problem.
In fact, a study by Xero shows that around 50% of business owners do not review their business on a monthly basis.
That approach can mean you’re missing out on issues that could be resolved. But by not knowing your numbers, you could end up with problems that remain unresolved and they become a bigger situation.
Once your business starts approaching or exceeding £1 million turnover, there are a lot more moving parts. More employees. More customers. Bigger bills. Larger tax liabilities. And potentially a lot more money tied up in the business.
That means looking at your bank balance occasionally is no longer enough.
7 financial KPIs for businesses
The good news is that you don’t need to spend your evenings studying spreadsheets. A good set of management accounts should give you the information you need to understand what is happening within your business – and help you spot problems before they become serious.
So, what should you be looking at?
Here are 7 financial KPIs for businesses that every MD should review each month.
1. Turnover
Let’s start with the obvious one. How much are you selling? Don’t simply look at this month’s turnover in isolation.
Compare it with:
- Last month
- The same month last year
- Your budget
- Your forecast
More importantly, ask why the number has changed. Have you gained customers? Have existing customers spent more? Did you increase prices? Is one unusually large contract making the figures look better than they really are?
Turnover tells you what’s happening at the top of the business. But it doesn’t tell you what’s happening underneath.
As we discussed in our recent article, Why your turnover is growing but your bank balance isn’t, increasing sales can actually put pressure on cash.
That’s why number two is so important.
2. Gross profit margin
Imagine your turnover increases by 10%. While that sounds great, it isn’t necessarily good news. That’s because the cost of delivering those sales might have increased by 15%! nd that means you could be working harder for less money.
Your gross profit margin shows how much of your sales income remains after the direct costs associated with producing your goods or delivering your services.
And the trend can be more important than the number itself.
If your margin was 40% last year, 37% six months ago and 34% today, something is happening.
Perhaps supplier prices have risen or you’re discounting too heavily. Or, perhaps your prices haven’t kept pace with your costs.
A declining gross margin can easily be hidden by increasing turnover. That’s why an MD should be looking at both.
3. Net profit
After you’ve paid the costs of running the business, how much are you actually making?
Turnover is something to talk about, but ultimately profitability is what makes a business sustainable. Compare your net profit with previous periods and with your budget.
If sales are increasing but net profit isn’t, find out why. You might be paying:
- Increasing wages;
- Higher premises costs;
- Additional finance costs;
- Extra software subscriptions;
- Or additional marketing or other expenses.
None may look particularly worrying when viewed in isolation, but they can collectively have a significant impact on profit.
It’s something we’ve looked at previously when discussing the importance of understanding the financial health of your business.
4. Cash
Profit and cash are not the same thing. You can have a profitable business and still struggle to pay the wages at the end of the month.
That’s because the profit showing in your accounts doesn’t necessarily mean the money is sitting in your bank.
It could be tied up in unpaid invoices or stock. You may have invested in equipment. Or perhaps you’ve got a large VAT, PAYE or Corporation Tax payment approaching.
This is why we like cash flow forecasts.
Don’t just ask: “How much cash have we got?” Ask: “How much cash are we likely to have in 30, 60 and 90 days?”
That’s a much more useful number when you’re deciding whether to recruit another employee, buy equipment or make another significant investment.
5. Debtor days
You’ve made the sale and you’ve sent the invoice.
But have you actually been paid?
Debtor days – sometimes called days sales outstanding – essentially tells you how long it is taking customers to pay you.
This can have a huge effect on a growing business.
Imagine a business turning over £1.2 million a year. That’s an average of £100,000 of sales a month.
If customers start taking an extra month to pay, that could potentially mean around £100,000 more is tied up in debtors rather than sitting in the company’s bank account.
That’s your money funding somebody else’s business. Your monthly figures should therefore tell you not only how much customers owe, but whether the time they’re taking to pay is getting longer.
Good credit control isn’t simply an administrative function. It’s an important part of financial management.
It’s one of the biggest financial strains on a business. According to the latest study, 62% of small UK businesses are owed money due to late or unpaid invoices.
6. Overheads as a percentage of turnover
As companies grow, costs have a habit of growing with them.
You recruit another person and add another software subscription. Then you need to lease another vehicle, spend more on marketing or expand into larger premises.
None of those decisions is necessarily wrong. In fact, they may be essential to growth.
The danger is cost creep. Looking at overheads as a percentage of turnover gives you a useful way of seeing whether the cost base of the business is expanding faster than sales.
For example, if turnover increases by 15% but overheads rise by 25%, you should understand why.
There may be a perfectly good explanation. But there may also be an opportunity to improve efficiency.
7. Your forward order book or sales pipeline
This one isn’t technically an accounting number, but it’s probably one of the most important figures an MD can know.
Your accounts tell you what has happened. Your pipeline helps tell you what might happen next.
How much confirmed work do you have for the next three or six months?
What’s sitting in your sales pipeline? How does that compare with this time last year?
And, crucially, is there enough work coming through to achieve your forecast?
We’ve previously looked at how your sales pipeline can improve your business finances.
If turnover looks fantastic today but the order book for three months’ time is looking thin, that’s something you want to know now – not in three months.
Don’t just know your numbers…
Producing these seven numbers isn’t enough. You need to understand why they’re changing.
That’s where management accounts become particularly valuable.
At Concept Accountancy, we believe accounts shouldn’t simply be something you produce after the financial year has finished.
For an established and growing business, they should be a management tool.
They should help you answer questions such as:
- Can we afford to recruit?
- Are our margins falling?
- Are customers taking longer to pay?
- Do we have enough cash for the next stage of growth?
- Are we actually becoming more profitable as we get bigger?
And ultimately:
- Are we building a stronger business?
HMRC’s Business Tax Account can help you keep track of your tax position, including VAT, PAYE and Corporation Tax. But understanding the wider financial picture requires looking at what is happening throughout your business every month.
Are you running your business through the rear-view mirror?
If you only properly review your figures when your year-end accounts arrive, you’re looking backwards.
By then, the opportunity to change what happened has gone.
Monthly management information gives you the opportunity to spot trends, ask questions and make decisions while there’s still time to make a difference.
And as your business grows towards £1 million turnover and beyond, that becomes increasingly important.
At Concept Accountancy, we help business owners understand the numbers behind their company – not simply produce accounts.
If your business is growing and you’d like a clearer picture of where you are, where you’re heading and what your numbers are really telling you, talk to us.
Because knowing your turnover is useful. Knowing what’s driving it – and what you’re actually making from it – is much more powerful.
