The 7 Most Important KPIs to Track as a Small Business
The 7 most important KPIs to track as a small business with key performance indicators examples
This article is about the 7 most important KPIs to track as a small business. In the article I also look at some key performance indicators examples.
There are too many small businesses and small business owners who don’t track KPIs. As a result, they don’t know what they are missing out on. They haven’t understood the power of a KPI.
Before I go into the 7 most important key performance indicators (KPIs), let’s take a look the the key performance indicators definition.
Key performance indicators definition and what does KPI stand for
KPI stands for; Key Performance Indicator. A performance indicator or a key performance indicator (KPI) is a type of performance measurement.
Generally speaking KPIs evaluate and measure the success of a business, but they can also be used as a measure to keep a check on failures too.
Success in terms of a KPI is where the business is progressing towards a particular goal or target. For example, to reduce customer defections to less than X%, or to increase lead conversions above Y%.
By recording and keeping a track of Key Performance Indicators, allows you as a business owner to know exactly what’s going on in your business.
Look at it as you would a dashboard in a car. Without the speedometer you may have an idea of how fast you are going, but you’ll not know the exact speed. This becomes more important when you are looking to keep within the set speed limit; to avoid road traffic fines.
The same is true for a business. You may have an idea of how good or bad you are doing, but without the numbers to support your ‘feelings,’ you’ll never really know. But more importantly, you’ll not have the measurements on which to focus, and from which to set new targets.
“If you can’t measure it, you can’t improve it.” Peter Drucker
So a business KPI is like having your own business speedometer or rev counter. This way you’ll know more about what’s going on in your business. But more importantly, you’ll have the management data to focus on and to make improvements. After-all, what you measure, you can manage; what you manage, you can improve.
Tracking and managing KPI’s is similar to an athlete trying to get the most out of his body.
What are the 7 most important KPIs to track as a small business?
In this article I am restricting the KPIs I look at to just seven. It was very difficult to do that, as there are so many important key performance indicators. But if perhaps you are new to business and not familiar with KPIs, beginning with the first 7 is a good starting point.
Starting by tracking just one KPI is better than not tracking any at all. If you were to pick just one KPI out of all seven, I’d go for the seventh key performance indicator.
However, I urge you not to jump to the end of the article. But instead read each of the seven KPI’s and decide yourself which one(s) you’d like to start with.
KPI number one – Gross profit margins…
The very first KPI I’m going to include in this article on the 7 most important KPIs to track as a small business is your gross profit margin.
Your gross profit margin is quite simply the profit your business makes on everything it sells. This margin is calculated before taking account of any overhead costs, such as rent, electric, advertising and other similar costs.
For example, if you sell a product for £100, and you buy it for £40; your gross profit is £60. This £60 represents a gross profit margin percentage of 60%.
Gross profit margin percentage is calculated as: Gross profit/Sales x 100 = Gross profit margin percentage.
In our example, this is calculated as: £60/£100 x 100 = 60%.
A business that doesn’t make a gross profit would never survive. Also, a business that doesn’t make enough margin will struggle to survive too. Low margin businesses have to run very fast to stay ahead. Very often a business that survives on a low gross profit margin has little room for error. Some times the slightest sip in sales can turn a small profit into a loss.
The total gross profit margin needs to exceed your total overheads, otherwise you’ll make a loss. A continuous loss over a long period of time cannot be sustained without sufficient investment and backing.
Explaining this using the first small business key performance indicators examples:
Lets assume that XYZ restaurant business currently has a gross profit margin of 55%. The restaurant currently has net sales of £150,000 per annum. This small business has overhead costs currently running at £95,000 per annum.
Looking at their profit and loss account:
XYZ Restaurant Profit and loss account
|Cost of sales (£150,000 x 45%)||(67,500)|
|Gross profit (55%)||82,500|
Currently, this restaurant business is making losses. So unless they have plenty of cash sitting around in the bank, they’ll not last for long.
What can this restaurant owner do about his loss-making business?
There are a number of things he can do, but for the purposes of this key performance indicator example, I want to look at the effect of improving gross profit margins on his business.
With the current gross profit margin of 55% his restaurant’s break even point would be to make sales of £172,727. Break even is where a business makes neither a profit nor a loss.
The example profit and loss with sales of £172,727 would be revised, as follows:
Revised XYZ Restaurant Profit and loss account
|Cost of sales (£150,000 x 45%)||(77,727)|
|Gross profit (55%)||95,000|
|Net break even||Nil|
You can see that he’d need to increase his sales by £22,727 in order to break even. This sales increase represents a 15% increase in sales.
There are a number of ways in which he could achieve this sales increase. However, for now let’s stay with looking at the impact of changing his gross profit margin percentage.
For this restaurant owner to achieve break even with the same number of sales as before, he’d need to increase his gross profit margin to 63.33%.
To demonstrate this by way of our example restaurant profit and loss account.
Revised XYZ profit and loss account with a 63.33% gross profit margin
|Cost of sales (£150,000 x 36.67%)||(55,000)|
|Gross profit (63.33%)||95,000|
|Net break even||Nil|
So now we have a third profit and loss account example. As you can see, the restaurant owner has managed to keep sales to £150,000, but his cost of sales have reduced. This produces a gross profit of £95,000, which matches his overheads. He therefore breaks even.
As it happens, restaurants on average spend around 32% on the cost of food and beverage. Therefore, with our example restaurant business there’s still further improvement to be achieved.
If the gross profit margin were to be around 68% (i.e. 100% – 32%), his profit would be £7,000 per annum instead. That’s a £19,500 shift in profits. That is, from a £12,500 loss to a £7,000 profit, which has been achieved by focusing on the gross profit margin.
Revised XYZ profit and loss account with 32% cost of sales and a 68% gross profit margin
|Cost of sales (£150,000 x 32%)||(48,000)|
|Gross profit (68%)||102,000|
This article is not about the ways by which a business can improve KPI’s as such, but rather about whiat are the 7 most important KPIs to track as a small business. However, that being said, I feel it necessary to explain a few solutions on how to improve KPI’s for you to get a better understanding of their importance in business.
In our restaurant example, what is likely to be the case of why the gross profit margin is so low is that XYZ restaurant is suffering from significant food wastage.
Waste food is the bug bear for most restaurants and their owners. The minimisation of wasted food is the key to a healthy gross profit margin.
Another way this restaurant owner could improve his gross profit margin in the above example is to improve on his purchasing process. He needs to find cheaper food and beverage suppliers, without any compromise on quality of the food or beverages.
KPI number two – Net profit margin
The second of the 7 most important KPIs to track as a small business is net profit and the net profit margin percentage.
A business’s net profit margin is the money made after taking into account all associated business running costs. In the above XYZ restaurant business example, the net profit (or loss) is the business’s gross profit less overheads, which in our example are £95,000.
Taking the last XYZ restaurant business profit and loss example, the restaurant made a net profit of £7,000.
This net profit represents a 4.7% net profit margin percentage, which is actually very low for a small business.
Net profit margin is an important key performance indicator for small businesses to track. Having up to date management accounts will provide this information. Having management information, such as an up-to-date profit and loss account, will help small business owners to stay on top of costs and overheads.
Tracking net profit margin as a business key performance indicator on a timely basis will ensure that the owner keeps ahead on how the restaurant is performing.
The owner may see what foods are wasted in the kitchen on a daily basis, but without the numbers, formulas and KPI’s to back this up, he’ll not know the exact impact the wastage is having on his bottom line profits.
Set your KPI’s as a target to hit
What is more important is to use KPIs as a target. So for example in our XYZ restaurant example, let’s assume he’s achieving £7,000 net profit. To get the best out of using KPI’s, is for him to set new targets.
Having a target provides a focus. Having something to focus on means the business is moving towards a target and is likely to better achieve and be more successful. This business owner may chose a new target of say £20,000 net profit, which represents a revised net profit margin of 13.33%.
This new total profit margin target may be able to be achieved through looking at cost reductions, i.e. finding ways to reduce the £95,000 and through increasing sales revenues. Of course he can also keep focusing on the gross profit margin too and get this as close to the 32% cost of goods sold target (or better) that he can.
Knowing your KPI and setting a new target is they key to getting the most out of key performance indicators.
KPI number three – Cash flow
Following on from net profit margin KPI, I couldn’t leave cash flow out of this list of the 7 most important KPIs to track as a small business. After all cash is still king.
You can make all the profits in the world, but it you fail to collect your profits in the form of cash banked, you will go out of business very quickly.
The best way to manage cash flow is to prepare cash flow forecasts. If a small business prepares cash flow forecasts on a regular basis, then these provide the metric on which to track and manage the various cash ‘inflows’ and cash ‘out-flows’ of the business.
The cash flow forecasts represent the base to work from. Cash flow projections also serve as an early warning mechanism for any cash short-falls that may occur. This is especially true for expanding businesses.
Where businesses are in their early growth stages, it’s vital to manage cash flow and avoid ‘over-trading.’ Preparing cash flow forecasts in advance, will identify any cash flow short falls well in advance so that the business can prepare for the situation. This way the business can take the necessary steps to avoid any problems.
Steps to take to avoid cash flow problems
These steps might include changing, for example debtor days (see below). It could also include re-arranging supplier credit terms.
Other steps may require the raising of additional funds, either from the bank and/or from external investors.
Banks and investors prefer to lend or invest with businesses that are well managed. They like businesses that are organised and that know in advance any cash short-fall they may have.
On the contrary, banks and investors are averse to business owners that leave things to the last minute. They don’t warm to entrepreneurs that are disorganised in this way.
Other KPI’s exist which have a big impact on cash and on small business cash flow. These in turn will lead to a bigger and better bank balance. One such key performance indicator is debtor days.
KPI number four – Debtor days
Debtor days is an essential KPI to track for all small businesses.
Keeping on top of your customer payments is key to good cash flow. Also, by limiting the level of credit and the length of time over which credit is given to customers will maintain good cash flow in your small business.
To calculated your debtors days on all debtors: Trade debtors/Sales x number of days in financial year = Debtor days
So for example if your business has £47,500 outstanding to customers at the month end. Lets assume your annual sales are £295,250.
Therefore, in this example the debtor days are: £47,500/£295,250 x 365 = 58.72 days
If this were your business, it would mean that on average customers are taking nearly 60 days, or two months, to pay your invoices.
Once you know your debtor days, you have a metric to track and you can now set a new target to meet.
You may set a new target of say 35 days to begin with. If we assume the sales are to remain unchanged in the above example.
So for your debtor days to equal 35, your new end of month debtors would become: 35/365 X £295,250 = £28,312.
In cash terms this would mean that you’d have an extra £19,188 in your bank at the end of each month.
How to review your outstanding debtors
When you review your outstanding debtors you need to consider two aspects to each amount outstanding.
- Number one; how much is outstanding, irrespective of the customer concerned.
- Number two; The age of the amount outstanding.
Conventional accounting packages only present this information in an aged format, without giving extra weight for older higher amounts outstanding. Whereas, I’d suggest you review your trade debtors on a ‘best-wins’ basis. That is, chase the highest and oldest accounts first. To highlight the point; your smallest and youngest trade debtors should carry the lowest weighting.
How to improve debtor days KPI
Apart from keeping on top of your debtors list and chasing them in the way I’ve describe above, there are a number of ways to reduce your debtor days KPI.
- The first method is to review your customer payment terms. It maybe that you will need to engage in a conversation with your customers to review the terms they have with you. This is especially true of your larger accounts.
- Make sure the invoice due date is clearly stated on all invoices.
- Include your bank payment details on all invoices and statements you send out.
- Send out prompt payment reminders, well before the due date.
- Consider offering early payment discounts. Be careful with this one, as quite often customers will pay late, but still take the discount.
- Raise your invoices in a timely manner, ideally on the day the goods or services are provided or soon thereafter.
KPI number five – Stock or inventory turnover
Stock or inventory turnover measures the number of times your stock is sold over a set period. This key performance indicator is good for revealing your business’s ability to move stock. Inventory turnover shows the number of times your company’s inventory is sold and replaced over a period of time.
There are two approaches to calculate stock turnover. The first method uses net sales, whereas the second approach uses cost of goods sold. I prefer to use the cost of goods sold method, as this provides for a more accurate KPI.
To calculate your stock turnover: 365/(Cost of goods sold/Average stock)
So in the example where your business has stock at the beginning of the year of £24,500 and at the end of the year it stands at £25,950. The average stock held through the year is calculated as (£24,500 + £25,950)/2 = £25,225.
Where the cost of sales for the same 12 month period was £225,175, the stock turnover is calculate: £225,175/£25,225 = 8.93; 365/8.93 = 40.9 days.
The results show that the stock is turned over on average 8.93 times per year and is on hand for an average of near 41 days.
Average stock turnover maybe the tip of the iceberg
Whilst having stock turnover as one of your key performance indicators is a good thing and a starting point to have, by calculating it in this way may hide all manner of hidden problems.
What you really need to do as a business owner, is to review your stock on a line by line basis. For example, by calculating stock turnover using an average may belie the fact that certain of your stock items are held for much longer than 41 days.
When reviewing stock turnover as a KPI there are two important factors to consider:
- How often the product is ordered by customers on a daily or weekly basis.
- How soon the stock arrives to your business (or how long does it take to make if you make the item yourself) after the order is placed.
You want to be able to hold the optimum level of stock to allow for new deliveries, whilst being able to satisfy the orders as and when they are place by your customers.
The last thing you want to do is to hold stock for excessive periods, as this represents cash tied up in stocks. There’s the risk that where stock is held for very long periods that it could become obsolete.
On the contrary, you don’t want to have stock levels too low, as this may give rise to missed orders or late deliveries.
One way to reduce stock, whilst at the same time as releasing cash into the business, is to hold a sale of the slow moving items.
KPI number six – Lead and prospect conversion rates
For any business, having a good flow of leads is essential. Without leads, business will dry up and the business will fail.
Before I go further in explaining this key performance indicator, I feel it’s important to distinguish between a ‘lead’ and a ‘prospect.’
Definition of a ‘lead’
There are many descriptions of a lead, as the term can be used in many ways. The closest description in the Cambridge dictionary is: “A piece of information that allows a discovery to be made or a solution to be found.”
A lead is concerned with the first contact a potential customer makes with your business. A good example of this is when a person makes first contact by completing an inbound web form.
Usually, this is what defines a lead, which means the initial communication is in one direction, i.e. from the ‘lead’ to the business.
Web forms are a commonly used method to gather leads. Often times, there’s an offer of a free download or a ‘gated asset.’ In exchange for a person’s name and email address, they are tempted with some information or a document containing ta free solution to a problem they have.
These ‘leads’ could be anyone. They are considered as ‘leads’ even though they may not have the authority, the intent or even the resources to purchase your products or services.
Definition of a prospect
In the dictionary a prospect is defined as: “The possibility or likelihood of some future event occurring.”
The way I would define a prospect is that a prospect is a ‘sales-ready-lead. Which means that it’s a lead that has been further qualified. This would be for example where a person has completed a simple online form to receive a freebie gated asset, but has been spoke with and been identified as a prospective customer.
This is better explain by way of an example. Let’s suppose you sell regionally within a certain county or town within the UK. Assuming you have a website that has a web form to gather leads, but that you occasionally have people from outside your area complete the form.
These people would be described as leads, but once they go through a qualifying process they’ll not become prospects. Unless you change your business model and begin to sell outside your local area.
What it can mean to a business to improve lead and prospect conversions
The KPI to track with regards to both leads and prospects is how well they both convert.
Ideally, you want as many of the leads you attract to be converted in to prospects. Then you also want as many of your prospects to convert into customers or sales.
To calculate your lead conversion rate: (Number of leads that convert to prospects/Total number of leads)
To calculate your prospect conversion rate: (Number of sales/Number of prospects)
How to improve lead conversion rates
When it comes to getting good lead conversions, this is about attracting the right people in the first place. Take the above website form example, where you want to make the funnel process as efficient as it can be. There’s no point in pouring the wrong things (or in this case people) into the top of a funnel and expecting the right things (or potential prospects) to come out the bottom.
Also, review your other methods of attracting leads. For example, do you use pay per click? If you do, keep an eye on ‘Negative keywords.’ Let me explain this by way of an example: I owned an ran a fitted furniture business and used Google pay per click extensively.
I had out-sourced the pay per click campaign. The company that the business was out-sourced to were not very good at reviewing the words that the ads were showing for. One example was where our adds were showing up for people searching for sofas, when we didn’t even sell sofas.
This is not only costly, but it also wastes valuable time and resources.
The are many ways to improve prospect conversion and as this article isn’t about how to improve KPI’s as such, I will limit the solutions to one or two.
How to improve prospect conversion rates
Having just spoken about leads, the first thing to get right is to have good leads in the first place. Make sure that all your leads go through a pre-define qualifying process. There’s no point in sending your sales reps out to see an an unqualified lead. You’ll end up wasting their time and you’ll have unhappy sales reps too.
The next improvement to make is the sales literature you use. What information do your sales rep take with them when they go to see your prospects? By your sales reps having the right materials and samples can make all the difference in how well prospects convert.
Explaining the benefits versus the attributes of what you sell is more likely to get a sale too.
As with any KPI; by creating the KPI; by setting the new target; and by asking the right questions; this will lead your small business down the right growth track.
KPI number seven – Average transaction value
If you were to ask “what KPI’s are the most important to running a successful business,” this would be the top key performance indicator that would get my answer.
I’ve ended on what I consider one of the most powerful and potentially under-rated key performance indicators. In fact, the average transaction value isn’t just a KPI, but it’s also a key profit driver too.
To calculate your average transaction value: (Total sales/Number of transactions)
For example, let’s take another look at the restaurant business described above. The annual sales were £150,000. On the assumption that the restaurant has 20 covers and on average does two overs per table per day. Also, let’s assume that the tables are on average filled for 40% of the time. Finally, let’s assume that the restaurant is open for 6 days a week for 50 weeks a year.
This means that the total number of transactions = 20 x 2 x 40% x 6 x 50 = 4,800 transactions per year.
Therefore in this example, the restaurant’s average transaction value is: £150,000/4,800 = £31.25.
Firstly, there are a number of problems that are highlighted with this restaurant’s numbers. Number one is the 40% table occupancy, which is extremely low. The second thing that stands out is the very low average transaction value of £31.25.
If this were your business and you were to focus on the average transaction value alone, this would dramatically affect your sales and profits in your business.
The cumulative affect of combining key performance indicators
Each of these KPI’s has been looked at individually and in isolation. However, when they are taken in amalgamation, the cumulative and combined affect they have your your business can be profound.
By setting targets for each of your chosen KPI’s and through improving on each one bit by bit, will begin to transform your business little by little.
Over time, the improvements made will be reflected in the accounts, which will show increased profits. But more importantly, the results will be reflected in the business’s bank account.
Key performance indicators templates
Bowraven has developed many Excel-based templates, which have become extremely popular with small business owners. All of these templates have been borne out from a business need. The first one we developed was the Cash Flow Forecast Template, which is ideal for tackling and focusing on cash flow. This was the very first KPI discussed in this article about the 7 most important KPIs to track as a small business.
The next business template to be developed was Increase Profit Software. This software template provides the ideal solution to target the seventh KPI and key profit driver – the Average transaction value.
I know that many people search for a key performance indicator template, but before we begin developing this template, I’d like to gauge the level of interest first. Please therefore complete our contact form with your details and put ‘key performance indicator template‘ in the subject field.
Once we know the level of interest, and assuming its high enough, we’ll set to creating this template to add to our business software. We’ll keep you on a list and let you know when the template has been completed.
What would be even more beneficial, is if you listed at least one or two key performance indicators on the message field on the contact page too.
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