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In any business setting, you need to be measuring appropriate Key Performance Indicators (KPI’s) to keep on top of the performance of the business. The basic process for utilizing KPI’s is:
- Identify what measurements are most important to your business
- Measure the “current state” of the KPI’s
- Establish targets for where you want them to get to
- Measure the KPI’s on a regular (usually monthly) basis
- Analyze the results and identify opportunities for improvement
- Hold employees accountable for the numbers that they are responsible for
Working Capital
Working Capital (WC) is Current Assets minus Current Liabilities. It is a measure of how well you churn cash through your organization. The two largest components of WC are Accounts Receivable and Inventory. If your inventory is too high, you are probably paying cash out too early and if A/R is too high, you’re not collecting fast enough.
Working Capital Turns
WC Turns are Sales/WC. It is a measure of liquidity and how well you utilize your WC. Higher turns are better – it indicates that you are converting your investments in the business into cash quickly.
Inventory Turns
Invetory Turns are calculated by Cost of Goods Sold (COGS) / Average Inventory. Higher turns are better. 6 turns means that you turn the inventory six times per year or, conversely, you have two months of inventory on hand. This ratio indicates how quickly your business is turning over inventory. A high ratio may indicate positive factors such as good stock demand and management. A low ratio may indicate that either stock is naturally slow moving or problems such as the presence of obsolete stock or good presentation. A low ratio can also be indicative of potential stock valuation issues.
Days of Inventory
This is a sister to Inventory Turns – just expressed in days. The calculation is 365 / Inventory Turns.
Accounts Receivable Turns
Accounts Receivable (A/R) Turns are a measure of how quickly you are turning sales into cash. The calculation is net sales ÷ average trade accounts receivable. High ratio means shorter time between sales and cash collection. Lower means the opposite. If ratio is lower than peers, the quality of AR should be examined. Note that ratio may be affected by seasonal fluctuations in sales or if a large portion of sales are cash based.
Days Sales Outstanding
Probably the most prevalent of the A/R related KPI’s. There are several ways to calculate DSO, including the clawback method, but the most common is 365÷ A/R Turns. DSO is an expression of the A/R turns in terms of days rather than annual cycles. The higher the number, the greater the probability of delinquencies. Interpret this in line with the company’s credit and collection policy or payment terms.
Past Due Percent & Past Due Dollars
These are two different measurements, but I list them the together because they should always be looked at together. Past due percent is the past due dollars divided by the total A/R. Because of fluctuation in sales month to month or quarter to quarter, the percentage can be skewed one way or the other by the fluctuation in sales. When analyzing the past-dues always look at both together or you’re only getting half of the picture.
For further assistance in measuring your KPI’s check out the Financial Analysis templates in Excel from InstantController.
For monthly A/R tracking templated with graphs that are ready for your data, check out the A/R Management Bundlefrom InstantController.
– John