In Part 2 of this blog post I’ll take a look at two more KPIs that senior financial professionals can use to identify risk and address weaknesses through timely reporting and mitigation. As I stated in Part 1, “Financial executives who identify critical issues early on, and who then use the data from KPIs to raise red flags (can) create the opportunity with business owners to take the require steps to address perceived weaknesses. Business leaders also must learn how to read KPIs effectively and understand the impact that those numbers have on the overall business.” Let’s turn to two more examples.
Inventory Turnover Ratio:
Formula: Cost of Goods Sold divided by Average Inventory
Days Inventory: (1 – Inventory Turnover) * 365 Days
The Inventory Turnover Ratio is an important measure of how well a company generates sales from its inventory. Inventory turnover is the number of times a company sells and replaces its stock of goods during a period. Typically, the higher the inventory turnover the better. Conversely, a lower turnover indicates less demand for the product because Inventory Turnover Ratio effectively measures how well the company is turning its inventory into sales. This ratio is important to shareholders and owners as it measures how easily a company can turn its inventory into cash. Creditors are interested in this as inventory can be collateralized and lending intuitions want to know that the inventory will be easy to sell. The CFO can use Inventory Turnover Ratio to show investors how liquid a company’s inventory is.
- Accounts Receivable Turnover Ratio:
Formula: Net Credit Sales divided by Average Accounts Receivable
Days Receivable: 365 divided by AR Turnover Ratio
The Accounts Receivable Turnover Ratio KPI indicates the rate at which your company is collecting its sales. This KPI allows business owners to indicate outstanding payments and focuses on maximizing the efficiency of your payment collections. Average debtor days monitor the number of days customers take to make payment. CFOs monitor this metric closely to determine if the turnover is at its most efficient to improve liquidity.
A CFO using KPIs will have greater insight into how well financial operations are running and can identify opportunities for using best practices to improve results. KPIs are business and industry specific and an organization should choose indicators that they believe provide the most insight into the company’s finances. Dashboarding the KPIs will allow for full transparency and give up-to-date results on the financial health of your company.