Monitoring KPIs to safeguard business growth and profitability
Dynamic, scalable, innovative, and efficient are often used to describe successful businesses. While many intangible factors that lead to satisfied customers and employees can be difficult to quantify, others can be baselined, measured, and tracked consistently to ensure expectations align with reality. This is the principle behind the metrics private equity firms monitor to ensure portfolio organizations stay on track.
In this blog post, we review some of the important metrics and KPIs private equity partners use to baseline and monitor business health, including those deemed most insightful for both insiders and investors. We also explain the benefits of establishing meaningful PE performance indicators.
What are performance metrics?
Business performance metrics are quantifiable measurements or calculations used to track organizational health and assess the ability to meet strategic goals. Operational metrics, for example, are valuable for improving productivity and the bottom line. While many of these metrics are tied to financial monitoring practices, others are driven by customer satisfaction and brand performance data. Common performance metrics tracked by businesses of all types and sizes include:
- Revenue growth: Indicating changes in sales revenue over time.
- Cash flow: Actual cash moving in or out of the business.
- Profit margin: The percentage of profit a company makes on its sales.
- Conversion rate: Measures the percentage of potential customers who complete a desired action.
- Customer acquisition cost: Average dollars spent on sales and marketing to acquire a new buyer.
Metrics are used to monitor business performance over time and for company baselining during due diligence. The baselining process includes a review of past and current performance to establish attainable goals for growth and improvement.
Metrics vs KPIs
Metrics can include any quantifiable measure of performance, efficiency, or progress that enables businesses and their private equity partners to identify areas in need of improvement and make informed decisions. Endless data sources have given us an equally limitless variety of metrics to track, which presents challenges for highly focused teams working towards aggressive growth objectives. Key performance indicators (KPIs) are the subset of metrics that are chosen based on their strategic alignment with high-level business objectives.
Private Equity KPIs and Benchmarking Practices
Portfolio company metrics must be evaluated with both the beginning and end in mind. This means applying a rigorous evaluation process upfront to determine the high-impact areas most in need of monitoring and improvement, then reviewing these KPIs regularly to ensure performance remains consistent with the unified vision. The key metrics selected for monitoring vary by organization, based on relevance and strategic growth objectives.
1. Gross margin stability
The gross margin formula (Revenue – Cost of Goods Sold) / Revenue is familiar to most business owners and investors, since it summarizes the profitability of a business using a simple percentage value. A high (or low) gross margin may be attributed to pricing strategies, production efficiency, shipping expenses, and other underlying factors, so an upward trajectory can reflect improvements in one or more of these areas.
Gross margin stability refers to the consistency of this value over time, meaning the company can balance the impact of each contributing factor successfully. Stability can also be evaluated according to industry norms to assess ongoing performance and competitiveness.
2. Capital intensity
The measure of revenue divided by fixed assets is known as the capital intensity ratio. This simple formula provides a glimpse into the financial health and efficiency of a business by revealing how well a company utilizes its existing assets to produce income. This metric provides a basis of comparison for investors reviewing similar organizations, while establishing a financial baseline for businesses moving toward operational excellence. Companies can influence this metric by outsourcing non-core functions, improving inventory management, and optimizing their capital planning.
3. Cash conversion cycle
The cash conversion cycle measures the time it takes a company to convert its investments in inventory and other resources into cash flows from sales. This metric is calculated as Days Inventory Outstanding plus Days Sales Outstanding less Days Payable Outstanding. A short cash conversion cycle means the company recovers its cash more quickly, which improves liquidity and reduces the need for external financing. Alternatively, a long cash conversion cycle may indicate inefficiencies in inventory management, collections, or payment terms.
4. Customer lifetime value
Customer lifetime value (CLV) reveals the total value a customer is expected to bring over the course of their relationship with a business. CLV can be calculated as the average purchase value multiplied by the average purchase frequency, and then multiplied by the average customer lifespan. Tracking this metric enables informed decisions on how to acquire and retain customers, allocate marketing resources, and refine product offerings.
5. Non-financial KPIs and benchmarks
Private equity KPIs outside the financial realm can also be strong indicators of business health and long-term stability. Evaluation practices have evolved to weigh factors like pay equity, promotion policies, and flexible work arrangements within an established scoring framework. While these metrics are important considerations for broader Environmental, Social, and Governance (ESG) investing strategies, high scores and positive trends also point to improved engagement, innovation, and brand reputation.
Employee retention is another important metric for human resources and management teams to monitor, since human capital is the driving force behind many of the key initiatives and operational improvements needed to maintain a positive growth trajectory. Since retention is a trailing indicator, teams should also pay close attention to metrics like employee engagement, PTO utilization, and training time to help predict upcoming trends in retention.
Conclusion
Private equity KPIs are among the most valuable tools available to monitor the growth of portfolio companies as they move toward operational excellence and predictable growth. Metrics based on reliable data sources help management teams keep their finger on the pulse as key financial, operational, and talent initiatives begin to unfold. By paring down the imposing list of metrics into a handful of KPIs, the growth trajectory of the business can be assessed accurately without weighing down stakeholders with endless data and reports. A prudent deployment of PE performance indicators not only reveals financial accomplishment but also highlights intangible factors, such as talent and customer experience trends, paving the way to success.