8 Key Performance Indicators to embed in your business strategy
Updated: Mar 5
Key Performance Indicators (KPI) are the statistics you use to help track how your business is performing.
When preparing a business plan, budget or forecast, you’ll be planning how to achieve your key business objectives. This process will set the KPIs that will subsequently be monitored through monthly or quarterly reviews. Your business may have high level KPIs for the overall business performance and unique sets for different business units/departments.
It’s important to know that having a KPI simply for the sake of it can be counter-productive. If your team can’t see the relevance of the KPI they can’t use them correctly. Or, even worse, they may be mis-used and focus attention on things that aren’t important to the business. Every KPI in your business must align to your objectives and goals in order to help achieve them.
Every business needs to set a strategy, build a financial plan, test sensitivities and track the KPIs which best support the needs of the strategy. Read our article on Business Planning to find out more.
Not all of the KPIs you will track will be financial, but all of them should be ‘countable’. If you can count something, you can measure it, and it’s the things you can measure that will be the basis of a business useful KPI.
Below, are some of the KPIs we have used very successful with our clients to help them achieve their objectives.
1. Gross Margin Percentage
· Formula: (Sales- Cost of Sales)/Sales
· Cost of sales are all the direct costs of your product or service; e.g. salaries, labour, stock, distribution costs
· It measures how much profit you make for each £1 you sell, how much of a mark-up your product or service attracts.
· It’s useful to compare to industry averages and will let you assess if you are in the range expected in your industry.
· Deviations around this KPI will alert you of the need to take corrective action.
2. Customer Churn/Customer Retention rate
· Formula: (Lost Customers/Opening Balance Customers) * 100%
· This measures the percentage of customers who stop using your product or services during a defined period.
· It’s important because it’s much cheaper to retain existing customers than acquire new ones.
· If you multiple this by the average revenue each customer gives you, you’ll be able to calculate the revenue lost by customers leaving.
· The customer retention periods formula is 1/Churn Rate – this will tell you how many of weeks/months/quarters or years your customer will stay with you (depending on the period you used for your original calculation).
· High customer retention rates are also a measure of good capital efficiency (that is money wisely spent).
3. Customer Lifetime Value (LTV)
· Formula: Average margin per customer/Churn Rate
· This formula calculates how much gross profit each customer generates over the average time they stay with the business
· It’s a critical number to understand how sustainable your business is, variations on this formula will use average revenue in the calculation.
4. Customer Cost of Acquisition (CAC)
· Formula: Marketing Costs/No of new customers acquired
· This measures the efficiency of acquiring new customers
· But it’s most useful as a metric when it is combined with the lifetime value.
5. LTV: CAC ratio
· Formula: (Average margin per customer/Churn Rate):(Marketing Costs/No of new customers acquired)
· This ratio is a true indicator of a business’s sustainability
· A ratio less than 3:1 is considered good. In other words, the value of a customer is 3x more than the cost of acquiring them.
· A ratio of 1:1 can mean that you are spending too much to acquire new customers, or that you are losing customers at an alarming rate. Conversely, although higher ratios are preferred, indicating that you have healthy customer retention percentages, when you’re business planning, they can highlight that you may be spending too little on marketing.
6. Net Burn Rate (Runway)
· Formula : Month End Cash Balance /Monthly Losses
· This is the rate at which a company depletes (i.e. burns) its cash reserves
· It informs you of how many months of losses the company can sustain until it runs out of cash
· It can be controlled and reversed by increasing revenues and reducing costs.
7. Debtor Days
· Formula: (Debtors Balance/Prior 12 months sales) *365
· This metric tells you how long on average your customers take to pay you.
· A high number, especially one greater than your payment terms, means that your cashflow is being restricted and put under pressure and the likelihood increases that the debt will not be paid at all
· It could also be an indicator of dissatisfied customers which other KPIs may be missing
· It is best to manage this metric carefully, keep it as low as possible, and investigate any reasons for its increase
8. What are Stock Turnover Days?
· Formula: (Total Stock / Monthly Cost of goods sold) *365
· This tells you how fast moving you stock is, and therefore how quickly you are converting your investment in stock back into cash
· The lower this number, the faster your stock is moving and it’s more likely that your stock is fairly new. However, a higher number indicates slow moving stock and the risk that there are growing amounts of older and obsolete stock in your warehouse, which is bad for your cash flow and your profits.
So, if you want to improve the health of your business and drive growth, start measuring these essential KPIs today. To find out more on measuring KPI’s and building an effective business strategy, contact the PCFO team for information.