Business Metrics

What are Business Metrics?

Business metrics are measurable indicators that provide valuable insights into the overall health of a company. These indicators are of great significance to potential investors and company managers.

In the modern financial world, data-driven metrics pave the way for success. These metrics act as the compass, guiding decision-makers toward informed and strategic choices. Understanding and harnessing the power of such insights are paramount for any organization.

The business metrics assess a firm's progress, identify trends, and uncover opportunities for optimization. They encompass a wide array of dimensions.

They take the form of 3 main metrics:

1. Financial metrics
2. Customer metrics
3. Employee metrics

In such a corporate landscape, mastering the art of interpreting and utilizing business metrics is key. However, these metrics' wide-reaching, complex nature can be hard to decipher. 

Business Metrics: Financial metrics

Financial metrics are measurements that offer important insights into the financial performance of an organization. Investors, analysts, managers, and other stakeholders frequently use them to evaluate a company's financial health and potential hazards.

They can be divided briefly into three distinct parts:

• Profitability Metrics - Metrics such as the gross profit margin, operating margin, and net profit margin measure a company's ability to generate profits.
• Liquidity Metrics - Ratios like the current and quick ratios assess a company's ability to meet short-term obligations.
• Valuation metrics - These compare a company's financials to its book value. Some examples are the price-to-earnings (P/E) and the price-to-book (P/B) ratio.

By providing a quantitative basis for analysis, financial ratios empower stakeholders to make informed choices in the complex world of finance. 

Profitability Metrics

Profitability metrics are essential for evaluating a business's financial performance in terms of profit generation. Here are some examples:

1. Gross Profit Margin

This is a standard measure used to identify a company's profitability and efficiency. It is most commonly stated as a percentage. The gross profit margin is the income that exceeds the cost of goods sold (COGS).

The formula for the Gross profit is:

Gross profit margin = (Net sales – COGS) / Net sales x 100%

2. Net Profit

Net profit is the ultimate profit after deducting all expenses, including COGS, operating expenses, taxes, and other non-operating costs. It is regarded as the bottom line of profitability measurement and is typically expressed as a percentage.

The formula for net profit margin is:

Net profit margin = (Net income / Revenue) x 100%

3. Earnings Per Share (EPS)

It is a measure that shows the company's earnings per common share. It is typical to have quarterly and yearly measurements. It is used to compute the profitability and total value of a company.

It can be calculated via several different methods. However, the most common is:

Earnings per share = Net income / Weighted average number of shares outstanding

4. Return on Investment (ROI)

ROI is a metric used to assess an investment's profit or return in relation to its cost. It helps assess the profitability of specific projects or investment opportunities. There are two ways to calculate ROI:

Method 1:

ROI = (Net Return on Investment /Cost of Investment) × 100%​

Method 2:

ROI = (FV−IV/Cost of Investment) × 100%

Where

• FV = Final value of the investment 
• IV = Initial value of the investment​

5. Return on Equity (ROE)

ROE measures a company's ability to generate profit from the shareholders' equity. It is a key metric for evaluating the efficiency of equity utilization. It is expressed in percentage form. It can only be calculated if net income and equity are positive.

The formula is:

Return on Equity = Net Income / Average Shareholders’ Equity​

Where

• Net income = income before dividends are paid
• Average shareholder's equity = equity at the beginning of the accounting period.

6. Return on Assets (ROA)

ROA is a metric that assesses the company's ability to generate profit from its assets. It encompasses all types of assets, such as current assets, accounts, and inventory receivables, excluding interest expenses.

The formula for return on assets is:

Return on assets = Net income / Total assets for the period

Liquidity Metrics

Liquidity ratios determine a company's ability to meet any short-term debt obligations. It doesn't include debt paid off with external capital. Among the various liquidity ratios, two of the most common are:

1. Current ratio:

The current ratio measures a company's ability to pay off its debt with its current assets. These include cash, inventory, and accounts receivables. Higher ratios generally indicate greater liquidity.

The formula is:

Current Ratio = Current Assets / Current Liabilities

2. Quick ratio

The quick ratio measures a company's ability to meet its debt with its most liquid assets, excluding inventory payables and receivables. It is also known as the acid test ratio.

The formula is:

Quick ratio = Quick assets / Current liabilities

Valuation Metrics

Valuation metrics help give investors an idea of the company's worth. This is a very vague metric and encompasses many KPIs. Here are the 3 most useful ones:

1. Inventory Turnover

Inventory turnover measures how often a company sells and replenishes its inventory within a specific period, usually a year. It provides insights into inventory management efficiency.

• Lower ratios indicate that the company is buying too much inventory or low sales.
• Higher ratios indicate a low inventory or robust sales. 

However, an excessively high value can be detrimental to the organization. It signifies that the company is experiencing high demand and is striving.

The formula for inventory turnover is:

Inventory turnover = COGS / Average inventory balance for the period

2. Debt-to-Equity Ratio 

The debt-to-equity ratio measures the company's financial leverage. It does this by comparing its total debt to its shareholders' equity.

High ratios indicate significant debt levels, which come with higher financial risk. However, this risk can be mitigated if the company effectively utilizes debt to generate stable cash flows.

The formula for the debt-equity ratio is:

Debt-to-equity ratio = Total liabilities / Total shareholders’ equity

3. Cash Flow Metrics

Cash flow metrics measure a company's cash generation, usage, and financing activities. It involves measuring their cash flows rather than income statements or balance sheets. A common example is the Operating Cash Flow Ratio (OCF).

The OCF measures the ability to pay off debts with cash flows from its core operations. Some current liabilities include accounts payables.

The formula for operating cash flow is:

Operating cash flow ratio = Operating cash flow / Current liabilities

Business Metrics: Human Resources Metrics

Employee metrics are quantitative measures used to assess various aspects of the workforce. It is also known as performance metrics. They identify issues to improve regarding employee performance, engagement, and overall organizational success.

Here are some types of Human Resources metrics:

1. Employee Turnover

Employee turnover is split into two parts—the rate of turnover and the subsequent costs. The turnover rate measures the percentage of employees that leave within a certain period. It helps assess employee retention and the effectiveness of talent management strategies.

The formula for the turnover rate is:

Employee turnover = Employees Who Left/ (Employees At The Beginning + Employees At The End) x 2

The turnover cost calculates the financial impact of employee turnover. These include recruitment, onboarding, and training expenses. The formula for turnover cost is:

Turnover cost = Total No. of Employees x Turnover Rate x Average Cost Of Departure

2. Employee Satisfaction Score

Employee satisfaction metrics gauge employees' satisfaction with their job and work environment. It is measured by using surveys or feedback mechanisms.

3. Absenteeism Rate

The absenteeism rate measures the percentage of scheduled work hours that employees are absent. High absenteeism may indicate underlying issues within the organization.

4. Time And Cost To Hire

• Time to Fill: This metric represents the average time taken to fill a vacant position within the organization, indicating the efficiency of the hiring process.
• Cost Per Hire: The cost per hire measures the average cost incurred to recruit and hire a new employee, helping evaluate the financial efficiency of the hiring process.

5. Sales Metrics

These metrics are quite straightforward, merely referring to the number of units produced. They are traditionally used in industries such as manufacturing.

This works best in industries where employees are charged with selling products, such as sales-related jobs. This holds with simple sales, which depends on an employee's skill, given time and location.

For sales with longer cycles, the procedure isn't as easy. Quantity is a KPI that is easier to assess than quality when dealing with complex sales cycles and may be measured in several different ways. This is especially important in modern industries dominated by complex yet efficient structures.

6. Product performance metrics

The product or service you provide should ideally follow a certain standard. This ensures that it answers exactly what it was set out to do. If not, be prepared to face lower sales and customer satisfaction rates.

Certain measures exist to help you judge your product's viability. The most straightforward one is the number of defects. This helps to measure your customer's experiences with your product and highlight production issues.

The Formula is: 

Number of Defects / Total No. of Products

When measuring these metrics, remember to evaluate the nature of work, set quota/ work assigned, and deadline.

Business Metrics: Customer Metrics

Customer metrics are vital for evaluating a company's relationship with its customers. They help quantify customer behavior, satisfaction, loyalty, and overall experience with the brand.

Businesses use these to improve customer relationships and increase their appeal to potential customers. Here are 5 common customer metrics:

1. Customer Satisfaction Score (CSAT)

CSAT measures customer satisfaction by asking them to rate their experience with a product, service, or interaction with the company. This is done via a customer service survey with a numeric scale from 1 to 10.

The formula for CSAT is:

CSAT = No. of Positive Responses / No. of total responses

2. Net Promoter Score (NPS)

NPS is a metric that gauges customer loyalty and the likelihood of recommending the company. Customers are asked to rate on a scale of 0 to 10, like CSAT. The NPS serves as a proxy for potential growth. It measures this based on your current consumer base and their satisfaction.

The formula for NPS:

NPS = % of Promoters - % of Detractors

An example question can be: "On a scale of 1 to 10, how likely are you to recommend us?" 

Depending on your score, you can learn about issues or positives in your service, whether it be quality of customer service, delay times, or effectiveness. Allowing customers to define their answers will help pinpoint the issue or the opposite.

3. Customer Churn Rate

Customer churn rate measures the percentage of customers who stop doing business with the company. A high churn rate indicates potential issues with customer satisfaction or loyalty.

Some signs of a high churn rate:

• The cancellation of subscriptions
• The closing of an account
• The stopping of services

The formula for Customer Churn Rate:

Customer Churn Rate = No of Customers Terminating within a Period / No of Customers at the Start of the Period 

4. Average Revenue Per Account (ARPA)

ARPA is a measure of the net profit generated by each customer. This metric helps in classifying high and low-revenue products. A growing ARPA can be interpreted in several ways.

If it grows while the number of customers stays the same, then the value of your products/services has grown. Otherwise, it is much harder to tell.

The formula for ARPA:

ARPA = Total Revenue/ Number of Accounts

• Total Revenue = Total income during the given period
• Number of accounts = Number of customers during the given period.

5. Customer Lifetime Value (CLV)

CLV estimates the profit customers will generate throughout their relationship with the company. It helps in identifying high-value customers and tailoring retention strategies accordingly.

Moreover, measuring CLV will highlight your most loyal customers. This allows you to increase spending to improve the revenue generated from them. Increasing revenue generated from an already loyal customer is easier than from a new one.

There are two ways to calculate CLV

CLV = ARPA / Churn Rate

CLV = (ARPA x Gross Margin %) / Revenue Churn Rate

This is used for differing ARPA across the customer base.

How to Choose the Right Business Metrics for You

Business metrics can help identify various facets of a business, such as strengths, weaknesses, opportunities, and threats. These are key guidances in strategic decision-making. However, not all business metrics are equally relevant and useful for every business.

Therefore, choosing the right metrics is critical in measuring what matters. Here are some steps and tips for choosing the right business metrics for your business:

1. Define your business's goals and objectives

The first step is to understand the main goals you want to achieve. These can range from core financial goals to more auxiliary goals such as employee wellness.

However, any new venture has various goals to achieve. This makes it difficult to pinpoint any existing problems. Therefore, it's important to determine the importance of each of them. A great tactic to use is the SMART method:

• S - Specific: Clearly define your objectives. 
• M - Measurable: Ensure you can quantify your progress. 
• A - Achievable: Set realistic, attainable goals. 
• R - Relevant: Align your goals with your business's mission and values. 
• T - Time-bound: Establish specific timeframes for achieving each goal.

2. Identify the key performance indicators (KPIs) that support your goals

KPIs are a subset of business metrics. They track the most important aspects of performance. They should be directly linked to your goals and reflect any success factors. This can be daunting, so here are some tips when choosing KPIs.

Your goals and KPIs should be narrowed down to adapt. Let's use an example to illustrate this.

Say you want to measure productivity quantity in the workplace. The increase or decrease in quantity produced can have many underlying reasons.

Examples can be sub-standard equipment and the stress of meeting high targets. Here, we see two separate factors to measure, which affect the quantity produced.

• Quality of equipment available
• Quality of life for employees

Both are wildly different yet have the same effect. But we can break these down even further.

The equipment quality could stem from various reasons, such as cost-cutting measures and general management ignorance. The latter reason shows underlying workplace issues need to be addressed.

A high stress level can also stem from various reasons, such as a heavy workload or insufficient mental health resources.

3. Choose relevant data sources and methods for collecting and analyzing it

Determining the source of your information is the backbone of any metric. A reliable source ensures accurate results, which you can work on effectively. Otherwise, you risk focusing your resources on issues that are minor or may not exist.

It might also damage your management, staff, and investors' confidence in you and your company. Thankfully, getting these is simpler than ever in the modern world.

Examples include large-scale web analytic software to measure traffic. These can range from customer surveys to measure satisfaction or financial statements to calculate profitability ratios.

4. Communicate and visualize your business metrics and KPIs effectively

The final step is to retell the stories concisely told by your metrics. Stakeholders and the public may not be well-versed in the intricacies of metrics, so effective communication is key. To ensure your data is comprehensible:

• Structure your results logically and clearly.
• Provide context and explanations for your data at each point.
• Highlight key insights and recommendations derived from the data.

Effective visualization techniques like graphs, charts, and dashboards can make complex data more digestible for all stakeholders.

There are a lot of formulas in this article, which can be quite overwhelming for many. But fear not! Here at Wall Street Oasis, we have many courses to help.

Excel is the most efficient and common medium of calculation in today’s financial world, but it can be confusing for newcomers. Thankfully, our course on Excel modeling is a great tool to help wrap your head around it.

Researched & Authored by Jake Jassim | LinkedIn

Reviewed and edited by Parul Gupta | LinkedIn

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