A cheat sheet of financial metrics for the well-rounded employee
For most modern enterprises, keeping a close eye on the financial and accounting metrics of the firm is the task of utmost importance: a responsibility usually allocated to the shoulders of dedicated finance teams within the firm. In this regard, although knowledge of a niche Berry ratio may not seem to be very useful to the average employee, it may prove prudent to know some of the major financial KPIs that govern most businesses.
According to esteemed technologist Bernard Marr, the four key indicators that businesses must keep under close monitoring are (i) Liquidity; (ii) Revenue, (iii) ROI (Return on Investment) and (iv) Profitability.
- Liquidity: Simply put, liquidity is the metric that tracks the amount of money available (at hand) to the business, i.e. its ‘working capital’. Formally, it is defined as the gross difference between current assets and liabilities, where assets include cash in the bank, invoices already sent out and inventory and liabilities encompass all accounts payable. A liquidity ratio of anything between 1.2 and 2.0 is considered ‘healthy, in this regard.
Furthermore, Marr adds: “When you’re examining your liquidity, it is also useful to assess your cash conversion cycle. How long does it take you to get a return after you’ve made an investment? If you put money into buying equipment, developing a new product, or taking on a project, how long does it take before you can collect money back? Over time, you want to reduce your cash conversion cycle as much as possible and generate better liquidity.”
- Revenue: Revenue, or sales, often regarded as the ‘top line’ (usually because it is placed right at the top of most financial statements), essentially tracks the amount of money that the firm is generating. This KPI proves especially useful in tracking monthly sales and examining revenue growth rates. It is this (potential) growth rate that most investors will stress on before putting their money into a firm.
In this regard, it may also prove useful to break down revenue streams by region and products to find whether the firm suffers from any part of ‘revenue concentration’, i.e. revenue being concentrated in one specific region, product or consumer, that may end up leaving the firm vulnerable to systemic risks.
- Return on Investment (ROI): This one’s simple, really. Investors will want to invest more in firms that generate the largest possible returns to their investments. ROI is thus a measure used to evaluate the efficiency of the investment, relative to the investment’s cost. This is done by finding the return, i.e. the difference between the final and initial values of the investment, and then dividing said returns (i.e. net return) with the cost of investment.
“For example, if you invest 1 euro in something and get 5 euros back, that’s a good ROI. In marketing, an ROI of 5 to 1 is good – if you get to 10 to 1, that’s an exceptional return on investment in the marketing realm.” (Marr)
- Profitability: Often called the ‘bottom line’ of the firm (also because it is usually found at the bottom of financial statements), business profitability is essentially a measure of the amount of money a business is left with at the end of a time period (a month or a year etc).
Every business will have its own costs, and once these costs are removed from the overall revenue, net profit is obtained. The key metric here, however, is net profit margin, which looks at profits relative to the revenue, i.e. the portion of revenue that is left as profit. While net profit margins vary wildly by industry, 10% is a good benchmark: while 5% is considered rather low, anything over 20% is comparatively high.
While several other financial metrics may need to be considered depending on industry, sector and region, the aforementioned KPIs should be treated as universal. And for those curious, here’s a PwC sheet on the Berry ratio: https://www.pwc.com/jp/en/taxnews-transfer-pricing/assets/tp-news-2014-04-e.pdf