What Are Key Performance Indicators (KPIs)?

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Key performance indicators (KPIs) refer to a set of quantifiable measurements used to gauge a company’s overall long-term performance. 

KPIs specifically help determine a company's strategic, financial, and operational achievements, especially compared to those of other businesses within the same sector.

***Understanding Key Performance Indicators (KPIs)

Also referred to as key success indicators (KSIs), KPIs vary between companies and between industries, depending on performance criteria. 

For example, a software company striving to attain the fastest growth in its industry may consider year-over-year (YOY) revenue growth, as its chief performance indicator. 

Contrarily, a retail chain might place more value on same-store sales, as the best KPI metric in which to gauge its growth.

* Tip- Key performance indicators (KPI) gauge a company's output against a set of targets, objectives, or industry peers.

***Types of Key Performance Indicators (KPIs)

Key performance indicators tied to the financials typically focus on revenue and profit margins. 

Net profit, the most tried and true of profit-based measurements, represents the amount of revenue that remains, as profit for a given period, after accounting for all of the company's expenses, taxes, and interest payments for the same period.

Calculated as a dollar amount, net profit must be converted into a percentage of revenue (known as "net profit margin"), to be used in comparative analysis. 

For example, if the standard net profit margin for a given industry is 50%, a new business in that space knows it must work toward meeting or beating that figure, if it wishes to remain competitively viable. 

The gross profit margin, which measures revenues after accounting for expenses directly associated with the production of goods for sale, is another common profit-based KPI.

A financial KPI is known as the “current ratio” focuses largely on liquidity and can be calculated by dividing a company's current assets by its current debts. 

A financially healthy company typically has sufficient cash on hand to meet its financial obligations for the current 12-month period. 

However, different industries rely on different amounts of debt financing, therefore a company ought to only compare its current ratio to those of other businesses within the same industry, to ascertain how its cash flow stacks up amongst its peers. 

***Special Considerations

KPIs do not necessarily have to be solely tied to financial data. 

While profits and debt levels are indeed important key financial indicators, a company’s relationships with both its customers and its employees are no less important to establishing its general health. 

Common non-financial KPIs include measures of foot traffic, employee turnover rates, the number of repeat customers versus new customers, and various quality metrics. 

***What Is Net Profit Margin?

The net profit margin, or simply net margin, measures how much net income or profit is generated as a percentage of revenue. 

It is the ratio of net profits to revenues for a company or business segment. 

Net profit margin is typically expressed as a percentage but can also be represented in decimal form. 

The net profit margin illustrates how much of each dollar in revenue collected by a company translates into profit.

Formula and Calculation for Net Profit Margin

R-COGS-E-I-T

=Revenue

=The cost of goods sold

=Operating and other expenses

=Interest

=Taxes

***What Is Leverage?

Leverage results from using borrowed capital as a funding source when investing to expand the firm's asset base and generate returns on risk capital. 

Leverage is an investment strategy of using borrowed money—specifically, the use of various financial instruments or borrowed capital—to increase the potential return of an investment. 

Leverage can also refer to the amount of debt a firm uses to finance assets.

***Understanding Leverage

Leverage is the use of debt (borrowed capital) in order to undertake an investment or project. 

The result is to multiply the potential returns from a project. 

At the same time, leverage will also multiply the potential downside risk in case the investment does not pan out. 

When one refers to a company, property, or investment as "highly leveraged," it means that item has more debt than equity.

The concept of leverage is used by both investors and companies. 

Investors use leverage to significantly increase the returns that can be provided on an investment. 

They leverage their investments by using various instruments, including options, futures, and margin accounts. 

Companies can use leverage to finance their assets. 

In other words, instead of issuing stock to raise capital, companies can use debt financing to invest in business operations in an attempt to increase shareholder value. 

Investors who are not comfortable using leverage directly have a variety of ways to access leverage indirectly. 

They can invest in companies that use leverage in the normal course of their business to finance or expand operations—without increasing their outlay.

***Special Considerations

Through balance sheet analysis, investors can study the debt and equity on the books of various firms and can invest in companies that put leverage to work on behalf of their businesses. 

Statistics such as return on equity (ROE), debt to equity (D/E), and return on capital employed (ROCE) help investors determine how companies deploy capital and how much of that capital companies have borrowed.

To properly evaluate these statistics, it is important to keep in mind that leverage comes in several varieties, including operating, financial, and combined leverage.

***What Is a Leverage Ratio?

A leverage ratio is any one of several financial measurements that look at how much capital comes in the form of debt (loans) or assesses the ability of a company to meet its financial obligations. 

The leverage ratio category is important because companies rely on a mixture of equity and debt to finance their operations, and knowing the amount of debt held by a company is useful in evaluating whether it can pay off its debts as they come due.

***What Does a Leverage Ratio Tell You?

Too much debt can be dangerous for a company and its investors. 

However, if a company's operations can generate a higher rate of return than the interest rate on its loans, then the debt may help to fuel growth. 

Uncontrolled debt levels can lead to credit downgrades or worse. On the other hand, too few debts can also raise questions. 

A reluctance or inability to borrow may be a sign that operating margins are tight.

There are several different ratios that may be categorized as a leverage ratio, but the main factors considered are debt, equity, assets, and interest expenses.

A leverage ratio may also be used to measure a company's mix of operating expenses to get an idea of how changes in output will affect operating income. 

Fixed and variable costs are the two types of operating costs; depending on the company and the industry, the mix will differ. 

Finally, the consumer leverage ratio refers to the level of consumer debt compared to disposable income and is used in economic analysis and by policymakers.

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