How to Use KPIs to Increase Profits & Cash Flow
When it comes to understanding your numbers, you may be asking yourself: what are Key
Performance Indicators (KPIs), and how do I use them to increase cash flow? Let us provide some insight as we highlight a couple of essential tips for understanding KPIs.
What is a Key Performance Indicator (KPI)?
A Key Performance Indicator is a number that is important and meaningful in monitoring and measuring the performance of your business.
KPIs & Relationships
KPIs are relevant because you are comparing one number to another to understand the impact of the relationship. These relationships are essential to understanding cash flow and the financial business model that makes the business profitable.
The three biggest KPIs that determine profitability on the income statement are:
- Cost of Goods Sold
- Operating Expenses
- Marketing and Sales Expenses
Different businesses in various industries have a different relationship to each of these main KPIs that determine the bottom-line profitability of the business.
Example: In a restaurant, the cost structure could be as follows. Also note, different types of restaurants in that industry can even vary as well. This is why understanding the financial model behind your business model is critical to profitability and financial success.
Sales $100
Food Costs $28 28%
Labor Costs $30 30%
Gross Profit $42 42%
Operating Exp $32 32%
Profit $10 10%
The Financial Business Model: KPIs to Hit Profitability & Cash Flow
If the restaurant above knows they control food costs to 28%, labor costs to 30%, and these two never exceed 58% — while operating expenses are controlled to hold bottom-line profit to 10% — their financial benchmarks will have been met. These numbers and their critical relationships are essential to get the finances of this business model working as the model was intended. If they are off, profitability will be off.
This is why understanding your business model, how it compares to others, and the key numbers that determine profitability and cash flow is essential. This comprehension empowers us to know what needs to be managed day to day to hit our target numbers. To explore this further, check out our articles on Executing a Numbers Based Strategy and Finally Understanding Your Numbers.
The 3 Most Important KPIs on Your Income Statement
Costs of Goods Sold
Some businesses have a cost of goods sold of 30%, 50%, or 60% of sales, which then determines the amount of gross profit left over to cover operating expenses and produce a profit. Whether you are in the restaurant industry, IT, manufacturing, or construction, the cost of goods sold will be different, and the relationship will be different. Different businesses within the same industries can also have different cost structures based on different ways of doing business, different niches, and different markets.
Operating Expenses
Businesses also have a different relationship between operating expenses and how much it takes in overhead to support the production of goods or services. These are the expenses that remain if you are not actively doing business. Even if you are closed on a Sunday or closed for the off-season, you may have rent or support staff on payroll regardless of sales coming in.
Marketing & Sales Expenses
How much does it cost you in sales and marketing expenses to generate each additional dollar of new sales? If you can go through the bank and exchange $10 for $20, you would make that trade every time. Marketing is the same, and we want to know, based on where we put our dollars, how much we are getting back. Whether this is generating new leads and converting them into sales or spending on campaigns and advertisements, in marketing, all activities can lead to supporting the bigger picture. Once a business grows and starts developing consistent cash flow, it becomes more important to see if the sales it has intended to generate happened according to plan or if a new plan of action is needed.
Drivers Behind the KPI
Monitoring the numbers that drive our KPIs is also critical. We need to know specific numbers from day to day to manage the financial performance of the business.
Example: Controlling scheduling is how to control labor. Making sure you have the foot traffic and average sale amount each time a customer enters will empower us to influence our numbers during the month while we still can.
Understanding the big picture allows us to understand the details we need to manage day to day and week to week.
KPIs Beyond the Income Statement
It is also important to view and compare numbers from one financial statement to another.
Example: How much equipment do you have, and what kind of sales can you produce or service with that equipment? If you purchase inventory, how long does it take to turn it into a sale? How many days is it taking to collect your receivables?
These are just a few examples to consider when comparing numbers between each statement. Then there is also the trend: the overall direction that sales, expenses, or cash flow are heading. Are things trending upward? Downward? Is your gross profit relationship getting better or worse?
Example: A restaurant owner received his income statement and saw his gross profit went down 1% each month. He slightly increased his prices the next month, and his gross profit got back in line by successfully implementing a numbers-based strategy.
Beware of the Data Monster
We can easily get lost in detail. Our ability to execute directly impacts our business results. Executing requires understanding big picture results and underlying details that drive those results: those are the KPIs and drivers. When first learning about our numbers, there can be a learning curve. We often think we have to measure everything, but that’s not the case. We need to be able to keep our numbers simple, but also understand them and use them to make better decisions. Remember, finances may seem complicated, but they are not infinitely complex.
Over time, we learn what our numbers are telling us and turn “what if” into “what is.” We learn what numbers matter and get us our results and which ones are most important to manage and monitor for financial profitability and success. And remember, you cannot control what you do not measure!
To learn more about obtaining and implementing these skills and tools in your business, Schedule a free consultation or call 262-796-1040.
Recommended Classes to learn more: Cash Flow Essentials & Cash Flow Fundamentals
