“What gets measured gets managed.”

The timeless adage is perhaps never more applicable than when it comes to business value. For advisors working with business owner clients understanding and routinely monitoring overall valuation is certainly critical – but it shouldn’t be their only focus.

The underlying key performance indicators, or KPIs, that make up the business value also reflect industry trends, potential risks and opportunities, financial and operational health, and more.

So which KPI or KPIs matter most when assessing the overall health of the business?

Ryan Thompson, BizEquity’s Valuation Analyst, explains that while it’s difficult to pinpoint a single KPI that’s the most critical, a business’s valuation is heavily influenced by cash flow, risk, and growth

To that end, the following seven KPIs can be used as levers for achieving business goals and driving valuation in an upward trajectory. (It’s also important to keep in mind that in a vacuum, these ratios are largely meaningless – which is why BizEquity’s software compares each company’s KPIs to the business’s own historical performance, the competitive landscape, and industry averages.)

  1. Cash-to-debt: Assesses a company’s ability to service debt with available cash. The formula for cash-to-debt ratio is operating cash divided by total liabilities. A higher ratio indicates a lower probability of defaulting on liabilities, and the inverse is also true: A lower ratio indicates a higher chance of defaulting.
  2. Debt-to-equity: Compares a company’s total debt to total equity. The formula for debt-to-equity ratio is total liabilities divided by total shareholder equity. The higher the ratio, the more risk creditors, lenders and investors face, which is why they tend to lean toward companies with lower debt-to-equity ratios.
  3. Interest coverage: Determines the ease with which a company can pay interest on outstanding debt obligations. The formula for interest coverage is earnings before interest and taxes (EBIT) divided by interest expenses. The lower the ratio, the greater the debt and possibility of bankruptcy. This ratio is most commonly used by lenders, creditors and investors to determine the riskiness of lending to a company.
  4. Days sales outstanding: Measures the average number of days it takes to collect receivables after a sale. The formula for this metric is average accounts receivable multiplied by days in the period divided by total credit sales. An increase in this ratio over time could signal difficulty in collecting from customers, indicating possible inefficiencies in the collection process.
  5. Inventory turnover: Assesses how many times a company’s inventory is sold and replaced in a given time period. The formula for this metric is net sales divided by average inventory. It indicates how efficiently a company’s goods are being sold, with a relatively low ratio suggesting weak sales or excess inventory and a higher ratio pointing to either strong sales or inadequate inventory.
  6. Return on equity: Measures how much profit a company generates with money shareholders have invested. This ratio, which is calculated by dividing net income by total shareholder equity, helps investors understand how efficiently a firm uses its capital to generate profits. 
  7. Cash flow-to-revenue: Measures a firm’s ability to convert sales revenue into spendable cash for the business owners. The formula for this metric is operating cash flow divided by net sales, with a higher percentage indicating higher cash flows and generally, a higher valuation. 

Each metric listed above can help advisors and business owners identify business trends, strengths and weaknesses. Looking at these KPIs on a regular cadence provides a roadmap for implementing any changes necessary to increase business valuation. It also gives advisors a chance to regularly touch base with their clients to ensure other pieces of their financial plan are on track. 

In a recent RIA Channel webinar, Ryan Thompson explained and applied these specific KPIs in depth. Take a look here. 

For financial advisors, there are five additional, industry-specific metrics that can help determine the trajectory of firm value:

  1. Total assets under management (AUM)
  2. Total number of clients
  3. Average age of clients
  4. How much of annual fees is recurring
  5. Five-year AUM growth

For more information about how BizEquity’s innovative valuation software can help advisors and their clients both understand and improve business value, click here.