Introduction to KPIs and Financial Ratios

Key performance indicators are the measurement of the most important factors determining productivity and/or the profitability of a business.  In addition to financial ratios they can examine the most important aspects of a business.

.
The difference between financial ratios and key performance indicators is that whilst financial ratios are applicable to almost any business enterprise, key performance indicators are usually unique in their relevance to a particular industry or sector. This difference can result in key performance indicators being more relevant due to their more specific nature.

Ratios are still a good analytical tool used to identify significant issues, and to determine financial condition and operational strengths and weaknesses of a business. Ratios used to create a series over time and used in comparison with industry standards greatly aid in determining the importance of a business and provide an indication of future performance. 

Important factors to consider when using ratios:

• a ratio is more meaningful if it can be compared against a benchmark figure or standard;
• when comparing ratios over time and against industry averages the most important factor is that they have been calculated on a consistent basis in order to ensure comparability; 

Limitations of ratios

• price level changes may produce misleading or distorted effects upon ratios from period to period when making comparisons;
• accounting policies adopted by a business may affect its result and require adjustments to be made;
• comparison of a business over a number of years can be complicated by continued expansion or changes in activity or direction;
• the diversification of business’s activities creates difficulty when attempting to compare ratio’s with industry sectors.