I recently commented on an article from FamilyBusiness.org that discussed private equity growth strategies that can also be applied by family-owned businesses to achieve similar results.   To follow up, I want to discuss KPIs that are important to consider when applying those strategies. I want to do this because financial visibility is key to managing growth.  

Antoine de Saint-Exupéry famously said, "A goal without a plan is just a wish."   I would add that a goal without measurement is simply an idea.

Without meaningful KPIs, business owners have no reliable way to determine whether their growth initiatives are succeeding or falling behind expectations.

KPIs should be monitored regularly, ideally through a dashboard. This gives business owners timely visibility into performance, and allows them to take corrective action when results begin to deviate from expectations.

There are hundreds of KPIs available to measure business performance. Some are applicable across industries, while others are highly industry-specific. For most growing businesses, it is best to start with a core set of financial and operational KPIs and then expand as reporting needs become more sophisticated.

Because there are many types of KPIs, I am creating a series of articles that explore each category separately. Each KPI provides a different perspective on business performance and understanding what these indicators measure can help owners gain greater visibility into the drivers of growth and profitability.

This first article focuses on Profitability KPIs. Subsequent articles will discuss:

• Liquidity KPIs
• Efficiency KPIs
• Growth KPIs
• Cash Flow KPIs

Profitability indicators are derived from the Income Statement. The most well-known indicator for profitability is net income, which provides the bottom line.  
Nevertheless, the multi-step income statement provides profit measurements at different stages such as after production, after operations and before non-operational expenses. This provides visibility of how revenue is used by different categories of expenses until it is converted into net income.

When net income is out of trend, profitability measures help to identify the type of expenditure that had major impact in the period’s unexpected results.﻿
Below is the list of profitability numbers found in a multi-step income statement:

1.	Gross Margin 

Gross Margin is the percentage of gross profit from sales. It tells owners how many cents of each dollar of sales go into production, and how many cents remain for all other expenses and profit. This indicator is useful when evaluating pricing strategies and production costs.

Gross profit, is the first profitability measurement in the multi-step income statement as it is the dollar amount from sales that remains after covering only the direct cost that takes to produce the product or to provide a service, which is called the cost of goods sold or COGS. For manufacturers COGS is usually the cost of the inventory, packaging, direct labor and shipping, and other direct costs related exclusively to the product. By excluding indirect costs from COGS, gross margin becomes less dependent on volume and more useful for breakeven analysis.

Normally, gross margin can vary drastically by industry and product. For example, according to the Construction Financial Management Association, the average gross margin for construction companies in 2023 and 2024 is around 26%, which leaves a small fraction of revenue to cover all other operational costs. However, in construction, labor and materials are usually included in COGS, leaving only administrative expenses as the remaining operational costs to be covered.

Gross Margin = (Net Revenue – COGS) / Net Revenue  

2.	EBITDA

EBITDA: Earnings Before Interest, Taxes, Depreciation, and Amortization. 
This indicator helps assess if a business is generating sufficient operating earnings. EBITDA is typically evaluated in dollar terms rather than as a percentage because it is commonly used by lenders to assess debt capacity, and by investors for business valuation.

Investors often have their own financing sources and frequently refinance debt when acquiring a company. As a result, they exclude interest expense when evaluating a company's earnings and cash-generating potential.

This is a very important indicator for business owners who are seeking an exit strategy.

However, investors don’t use this number as it appears in the company’s financial statements.   They do an additional process called Quality of Earnings or adjusted EBITDA, which excludes all transactions that are unlikely to happen as the normal operations of the company as well as (mostly in small businesses) any owner expenses or compensation.

3.	Return on Sales (ROS) or Operating Margin

This percentage provides a complete picture of how much of the revenue goes into covering all expenses required for the operations of the company and for that reason it is considered an indicator of operational efficiency. The indicator is based on EBIT or Operating Income, which is the earnings before interest and taxes, therefore it considers indirect operational expenses such as rent and salaries, which were not included in COGS. For that reason, ROS is an indicator of operational efficiency.

For example, a company with $100 million in revenue and $8 million in operating income has an 8% operating margin, meaning it retains eight cents of operating profit for every dollar of sales before interest and taxes.

ROS=EBIT/Net Sales

4.	Net Profit Margin

This is the bottom line, and it is calculated as the final net income divided by net sales.

Net Margin = Net Profit / Net Sales

As seen above, profitability KPIs provide a complete view of how dollars go into each stage of the expense of the company (COGS, operations, interest and taxes), helping management identify which operational and financial improvements may have the greatest impact on profitability.

Profitability KPIs also help to visualize where out of trend results originate. For example, if regularly profit margin is 5%, and in one period there is a loss of -3%, seeing the trend of all stages of income, helps to identify whether the impact comes from an increase in COGS, from other operational expenses.

Owners may benefit from monitoring these indicators in dashboards and comparing them among different periods. This level of visibility helps business owners make informed decisions that support their growth objectives.

In the next article, I will discuss Liquidity KPIs and how they help businesses maintain financial flexibility while pursuing growth initiatives.

Financial KPIs for Growing Businesses Part A - Profitability

Munoz FP&A LLC