Best Finance Metrics to Measure Performance (With Details)
By Indeed Editorial Team
Updated June 10, 2022
Published January 3, 2022
The Indeed Editorial Team comprises a diverse and talented team of writers, researchers and subject matter experts equipped with Indeed's data and insights to deliver useful tips to help guide your career journey.
When an organization wants to monitor its financial performance and plan for future goals, they use some specific financial metrics. These metrics can help the company monitor its success, improve internal processes, and drive growth. Understanding how an organization measures its financial performance can help you improve your knowledge related to its decision-making process. In this article, we discuss what finance metrics are, what makes a good metric, and the top metrics to monitor.
What are finance metrics?
Finance metrics are systems or a standard of measurement that an organization uses to track, control, and analyze its financial health. These metrics fall into various categories, such as liquidity, profitability, efficiency, solvency, and valuation. Liquidity refers to how easily a company can convert its assets into cash without affecting its market price. Profitability is the degree to which a business may produce profits. Solvency refers to the company's ability to pay its debts. Efficiency happens when an organization reduces consumption to produce goods or services. While valuation refers to how a company determines the fair value of an asset.
By monitoring these metrics, an organization can be in a better position to understand how they're performing financially. They can use this information to change their team or department goals and contribute to their critical strategic objectives. These metrics can show significant warning signs and when an organization's operations are running efficiently.
What makes a good metric?
Most of the financial metrics that an organization can come across are common and effective. These metrics can vary depending on the industry, but they have become standard because of financial reporting requirements. The following can help outline what an organization may consider when deciding which metrics work best:
Goals: Organizations may choose a metric depending on their financial goals and the timeline to achieve them. For example, they may want to measure their solvency within a year.
Data: Companies often choose trackable metrics where they can use numbers and quantitative interpretations. For example, an organization can collect the number of products they produced in a year.
Sources: Organizations may use data sources that are consistent and reliable. For example, their metrics might outline when and they collect data.
Reports: Companies may use only the metrics they can add to a financial report. For example, they can inform the company's revenues to their stakeholders by delivering their annual financial statement.
Top metrics to monitor
You can use the following finance metrics to get a complete understanding of an organization's financial health history and an accurate prediction of its performance in the future:
Gross profit margin
This metric is a vital measurement of the efficiency and profitability of an organization's core business. The metric calculates this measurement as gross profit divided by net sales and expresses the result as a percentage. The gross profit of an organization is the net sales minus the cost of goods sold (COGS). COGS is the direct cost of producing an organization's product that it sells. It's easier to calculate profit as a percentage of revenue to analyze an organization's profitability trend over time and compare its profitability with its competitors. The gross profit margin formula is:
Gross profit margin = (net sales - cost of goods sold) / net sales x 100
Return on sales (ROS) or operating margin
This metric looks at how much the organization's operating profit generates from every dollar of sales revenue. You can calculate this as operating income or earnings before interest and taxes (EBIT) and divide it by the net sales revenue. An organization's operating income is its profit on sales revenue after subtracting COGS and operating expenses. Organizations commonly use ROS to measure how efficiently it turns revenue to profit. The ROS metric formula is:
ROS = (earnings before interest and taxes / net sales) x 100
Net profit margin
The net profit margin is a measure of how much profit an organization has made after considering all the expenses. You can calculate this metric as the net income and divide it with the revenue. Organizations often regard net income as the best profitability metric and refer to it as the bottom line. This is the profit that remains after subtracting all operating and non-operating costs. You can express net profit margin as a percentage after using the following formula:
Net profit margin = (net income / revenue) x 100
Operating cash flow ratio (OCF)
This metric of liquidity ratio measures an organization's ability to pay short-term liabilities with the cash it generates from core operations. You can calculate this metric by dividing operating cash flow by current liabilities. Cash flow refers to the movement of cash in and out of a business. An organization's OCF is the cash it generates from its operational activities.
The current liabilities include the accounts payable and its other various debts that are due within a year. Usually, the OCF uses the data from an organization's cash flow statement and not the balance sheet or income statement, which removes the impact of the organization's non-cash operating expenses. The formula to determine the operating cash flow ratio is:
Operating cash flow ratio = operating cash flow / current liabilities
The current ratio shows an organization's short-term liquidity. This is the ratio of an organization's current assets to its current liabilities. The current assets are assets that an organization can convert into cash within a year. This includes cash, inventory, and accounts receivable. Accounts receivable are asset accounts included in the company's balance sheet and represent the money due to the organization in the short term.
The current liabilities are all of an organization's liabilities due within a year, including accounts payable. These are the debts a company owes to its suppliers or other companies. Typically, if the current ratio is below one, it can be a warning that the organization doesn't have enough convertible assets to pay for its short-term liabilities. The formula to determine the current ratio is:
Current ratio = current assets / current liabilities
This is a liquidity metric that an organization often uses in combination with other liquidity metrics, such as the current ratio. Similar to the current ratio, the working capital compares the organization's current assets with the current liabilities. But it displays the result in dollars and not as a ratio. Low working capital can signify that the organization may not meet financial obligations. But an excessive amount of working capital can show it may not be using its assets optimally. The working capital formula is:
Working capital = current assets - current liabilities
Cash conversion cycle (CCC)
The cash conversion cycle is a quantity that helps organizations evaluate how efficient their management and operations processes are. It measures the time an organization may use to convert its inventory investments and other various resources into cash flow from its sales. A CCC that doesn't change or decreases is a reasonably good sign, but if it rises, the organization can make some additional analysis. This metric can differ between industries depending on the organization's business operations. The formula for CCC is:
Cash conversion cycle = days of inventory outstanding + days of sales outstanding - days payable outstanding
Accounts payable turnover
This metric is a short-term liquidity finance metric that shows how quickly an organization can pay suppliers and other bills. You can calculate this metric using an organization's total purchases from vendors and divide it by the average accounts payable. The accounts payable turnover ratio is a sign that shows how many times an organization pays its average accounts payable balance in a specific period, such as a year. If an organization has an increasing accounts payable turnover, it shows that they're paying suppliers at a faster rate. The formula for accounts payable turnover is:
Accounts payable turnover = total supplier purchases / average accounts payable
Accounts receivable turnover
The accounts receivable turnover measures how quickly an organization collects payments that outside parties owe and displays how effective the organization is when extending credits. This metric measures how many times an organization collects its average accounts receivable. Accounts receivable refers to the money that clients owe to a company for products or services. You can calculate the accounts receivable turnover by dividing the supplier's purchases by the average amount of accounts receivable. The faster an organization can turn its credit sales into cash, the higher its liquidity.
Suppose the organization has a low accounts receivable turnover. In that case, it can signify that it can consider revising its credit policies to ensure that there are more timely payment collections in the future. The formula for accounts receivable turnover is:
Accounts receivable turnover = sales on account / average accounts receivable
This metric expresses the difference between an organization's actual performance and forecasts or budgets. The budget variance can analyze any finance metrics, such as profitability, revenue, or expenses. An organization can state the budget variance in dollars or a percentage of the budget total. The budget variance can be favourable or unfavourable, which can result from various internal and external factors such as a poor budget plan, labour costs, and changing business and industry conditions.
The goal of the variance is to keep the organization's revenue higher than its budget or the expenses lower than it predicts. If the organization's revenue is less than the budget, expenses become higher, and the variance becomes unfavourable. The formula for budget variance is:
Budget variance = (actual result - budget amount) / budget amount x 100
Explore more articles
- Guide to Managing Clients (With Definition and Strategies)
- What Is Metadata and How Do You Use it? (With Types)
- What Are Retail Banker Responsibilities? (With Tips)
- How to Use a Product Backlog (With Definition and Benefits)
- Understanding MBA's Meaning (Types and Available Jobs)
- What Is Journal Entry Format? (How to Make a Journal Entry)
- How to Get Subscribers on YouTube (Importance and Tips)
- What Is Requirement Traceability? (With Benefits and Tips)
- What Is Product Design? (Including 7 Process Steps)
- 9 Staff Management Strategies to Maximize Team Performance
- What Is a Backorder? (Including Pros, Cons, and Uses)
- Overview of Unbranding (Definition, Benefits, and Examples)