Key performance measures help people evaluate actual performance against objectives, so they know what levers to pull to stay on track. As finance plays a vital role in an organization’s critical decision-making, we’re going to take a look what KPIs to set. The significance of having the ability to measure financial KPIs means businesses can get closer to customers. Finance data closes the time gap between customers’ demands and businesses’ response to them.
How are KPIs set-up in the finance function?
In finance, KPIs are set up in the form of financial ratios, using which, you can analyze the company’s financial performance against its past performance, competitors’ performance and general industry performance.
Analyzing and interpreting the entire financial data can be a cumbersome task at times, especially, when you require critical insights for day-to-day decision making. In such situations, financial ratios are useful because people can quickly measure the performance and make necessary changes to the strategy or business plans.
Efficiency ratios are a good way to determine how well your organization is utilizing its assets and resources as long as the data is up-to-date. However, for the finance team, the calculation of efficiency ratios may become a cumbersome process since it has to pull data from the ERP into a spreadsheet, apply formulas, and calculate the ratios.
If a figure gets updated in the ERP, then the finance team has to pull the new data and repeat the process which takes time. Also, a lot of human intervention is involved, so it’s likely for error or mismatch.
How can the finance team automate the calculation of financial ratios?
The finance team needs to investigate a finance data analytics solution like Phocas that pulls data from one or more ERPs and consolidates them in one place. Through interactive, visual dashboards, the users can filter data by period, region, or other data points, calculate the efficiency ratios at the click of a button, and drill down into specific data to see detailed insights in real-time. Calculating ratios is simple, users just drag and drop the relevant column names into the dashboard, and the system will automatically calculate the ratio.
Also, as the need arises, two or more KPIs, such as Inventory Turnover and Asset Turnover can be placed side-by-side to uncover hidden patterns and gather more insights for better decision making.
What are some essential efficiency ratios that should be set up as a KPI?
Efficiency ratios are also called Activity Financial Ratios and are used for measuring how well a company is utilizing its assets and liabilities resources. The higher the ratio the healthier and more efficient the business. Here’re the most important efficiency ratios:
Asset turnover ratio
This ratio analyzes whether a company is using its assets efficiently to produce the set revenue for a given fiscal or calendar year. A company invests in current and fixed assets to increase its sales in the future. But if a company’s assets are not making any substantial contribution to the sales, it shows inefficiency.
Asset Turnover = Net Sales Revenue / Total Assets
The faster a business can sell its existing stock and replace it with new stock, the better is the business’s performance. A high turnover means the company is generating returns quickly on the investment by earning profits. If the company is unable to sell the existing stock at quicker intervals, it’s likely that the company needs a more robust purchasing, production, sales, or supply chain strategy.
Inventory Turnover = Cost of Goods Sold / Average Inventory
Days sales outstanding
For any company, collecting cash from customers swiftly is crucial to maintain the working capital and liquidity position. DSO ratio, also called the average collection period or days’ sales in receivables, calculates the number of days that a company takes to collect cash from its debtors.
Days Sales Outstanding = Accounts Receivable/Sales x 365
Days Payable Outstanding (DSO)
Every company aspires to delay its payables and use the cash for short-term investments and increase its working capital. However, the decision-makers must ensure that the DSO ratio is not too high as it can ruin the company’s reputation and deter others from trading with you.
The days payable outstanding (DPO) ratio calculates the average time it takes a company to pay its invoices from suppliers and vendors.
Days Payable Outstanding = Accounts Payable/COGS x 365
Apart from these critical efficiency ratios, financial data analytics software like Phocas allows you to calculate other efficiency ratios like the Cash Conversion Cycle (CCC) ratio and more.
Utilizing the right tools means keeping things simple, finance teams are focusing on collecting the right data and presenting it clearly to the business, to drive the right business outcomes. Teams are then building on that foundation with data insights – allowing the company to find new opportunities and long term value for the business.
Phocas' financial solution is an easy-to-use platform to share key financial information across your team. It will help open the lines of communication between the people who are reviewing the numbers and the finance team and no matter where the conversation is taking place; everyone is working from the same numbers.
To find out more about financial KPIs to automate and measure, download this ebook: Turbo Charge your finance team with Data Analytics.