Four Key Performance Indicators to Measure Your Company’s PerformanceBy
As we get closer to the end of the year, it’s time to evaluate your business’ success. Here are four key performance indicators (KPIs) to help evaluate your business’ performance and start planning for the future.
1. Capacity Utilization Rate = Actual Output/Potential Output
Capacity utilization is a very effective way to measure your business’ efficiency within the confines of your own production limitations. For a manufacturing facility, this may look like units produced over a period of time, divided by the maximum potential output within the same time frame. A service industry may measure this as actual services performed, divided by possible services performed. At 100% capacity utilization, you risk employee burnout or quality concessions, whereas at a capacity utilization rate of 60%, you open the door to underutilizing your company resources. Across industries, capacity utilization rates of high-performing businesses tend to hover slightly above 80%. Evaluate your capacity utilization to determine if you are appropriately utilizing your machinery, labor, etc. To strengthen a low-capacity utilization rate, consider the following factors:
- Invest in new equipment with less downtime for repairs
- Expand marketing efforts to increase product or service demand
- Evaluate business processes for efficiencies
2. Cash-to-Cash Cycle = Days Sales in Inventory + Days Sales Outstanding – Days Payable Outstanding
(Average Inventory/(COGS/Days) + ((Accounts Receivable/Total Credit Sales) x Days)) – (Accounts Payable x Days / COGS)
The cash-to-cash cycle is important for every business, and especially new businesses. The formula is essentially the duration amassed between when inventory is purchased, to when a customer pays for it. The lower this ratio, the faster cash is realized. Many public manufacturing companies reported a cash-to-cash cycle in 2020 of around 25-50 days. Taking the time to evaluate your cash-to-cash cycle may mean spending more time with your money in your pocket, instead of someone else’s. To speed up your long cash-to-cash cycle, consider the following factors:
- Tighten up offered credit terms
- Reduce on-hand inventory
- Prolong payment to suppliers
3. Inventory Turnover Ratio = Cost of Goods Sold/Average Inventory
Work in process and inventory management are key factors in determining the efficiency and potential of your product cycles. Lower inventory turnover ratios in relation to industry averages may mean that your business has had a period of poor sales or has been stocking too much inventory. High inventory turnover ratios may indicate a strong period of sales, or minimal inventory on-hand. It is important to consider the possibility of a very high inventory turnover ratio disguising poor inventory management. Generally, a strong inventory turnover ratio is 1.5-2.5, however this is very dependent on the type of industry and good produced. Compare your inventory turnover ratio to prior periods to track progress, as well as public companies in your industry to gauge how you compare. To improve your inventory turnover ratio, consider the following factors:
- Invest in regular supply and demand forecasting
- Discount slow moving products
- Reduce purchase quantities
4. Net Profit Margin = ((Revenue – Expenses)/Revenue))
For many small business owners, net profit margin is the most important metric to track. Often, net profit margin is representative of the amount of money that is either added or subtracted to the bank account at the end of the period. A company with $1 million in revenue and a net income of $50,000 has a net profit margin of 5%. Increasing this margin by only 1% provides a large benefit to a small business owner. Companies with tight net profit margins saw the ramifications over the past year and a half as labor and material costs have both increased significantly. Giving yourself some more wiggle room in the bottom line might make all the difference between a thriving business and one that is treading water. To increase your low net profit margin, consider the following factors:
- Renegotiate fixed costs, rent, utilities, etc.
- Outsource business processes such as payroll
- Increase the prices of top selling products
The faster that you can get a grasp over the relevant KPIs in your industry, the more likely you will be able to make informed decisions. I would recommend building your own tracking tool with historical comparison to track improvement over time. Utilize one, or all, of these KPIs as you the year-end approaches and evaluate the improvements you can make as we head into the new year.