Back To CourseSenior Professional in Human Resources - International (SPHRi): Exam Prep & Study Guide
10 chapters | 86 lessons
Douglas has two master's degrees (MPA & MBA) and is currently working on his PhD in Higher Education Administration.
Financial metrics are quantitative measures that business managers and analysts can use to assess the performance of their business. They can be of most use to those who have jobs in finance and accounting, but they are important for everyone to understand because they tell us about the financial health of a company. Investors will demand to know them. Employees should be interested in them, and managers will use them to hold themselves and everyone else accountable.
In fact, one of the benefits of financial metrics is to make sure that everyone understands how their job and department impacts those financial metrics. When someone has ownership for a key part of a financial metric that they know will be seen by others, they put a lot of effort into making sure their numbers look good.
The metrics we'll talk about is this lesson does not represent a complete list. But we will discuss some that are common and fairly simple.We are going to go over four important financial metrics: return on investment (ROI), internal rate of return (IRR), cost per hire, and the net profit margin.
The return on investment (ROI) isn't usually calculated as a financial metric based on the entire company; although, it can be. It is best used to evaluate the return on the investment in a project.
For example, if a company is considering building a $1,000,000 production line for a product that will sell $300,000 per year for five years, then that $1 million investment will generate $1.5 million in sales ($300,000 * 5 years).
Here's the formula for ROI, which we'll talk through in the next paragraph:
Of that $1.5 million, only $500,000 is profit, and since the investment was $1 million, that's a 50% return. BUT, don't forget that it is measured over five years. If we want to turn that into an annual return, we need to divide it by the appropriate number of years. So, 50% divided by the 5 years the production line was used is 10% per year. The company's investment had a ROI of 10%.
Like the ROI, the internal rate of return (IRR) is an internal financial metric that managers can use to compare the financial payoff of different projects or investments. The IRR formula discounts the future cash flows of an investment to make the net present value equal to zero. To do that, you need to assume a discount rate at which the cash flows are discounted. The higher that rate, the better the investment.
While there is a formula for IRR, it's for theoretical purposes, not to use in actually calculating IRR. Calculating IRR requires some basic data analysis software, like Excel. If you use Excel, you simply use the =IRR() function; the only input required is the future stream of cash flows. The only thing you need to remember, no matter what data analysis package you use, is that your 'year 0' cash flow (which means now) is a negative number - the total amount you need to invest now. When you use Excel, all it is doing is taking the cash flow from year 1, discounting it at the necessary rate to make the present value zero, and doing that for the entire useful life of the project. The project with the highest discount rate is the most profitable.
The net profit margin is one of the most basic financial metrics used in business - both by internal managers and external investors. Simply defined, the net profit margin is the percent of revenue generated that is not used to pay for the cost of goods or services and some portion of overhead costs. The formula is quite simple:
So, if you started your own business and made $200,000 your first year and $120,000 of that were costs, like raw materials, machines, packaging, etc., that means you actually made $80,000 profit ($200,000 - $120,000). To figure out net profit margin, per the formula, you simply divide $80,000 by $200,000 and come up with 40%. That's pretty good. Grow that business now!
Not all financial metrics have to do with how much money is made or how much is spent on production. The cost of hire can be a tough metric to figure out, depending on how many people a company hires. If they hire very few people, it can be easy to track, but hiring a lot of people can be tricky because it is found by totaling all recruiting-related costs and dividing it by the number of full-time equivalent hires.
Once an HR manager can identify all of their recruitment and hiring costs, by unit or for the whole company, and then divide that by the number of hires, they've calculated the cost of hire. This is most useful to use in a year-to-year comparison to track hiring expenses and the return on investment in new employees.
The common financial metrics discussed in this lesson are all important to understand when analyzing a company and its financial health.
ROI and IRR are important metrics to use when comparing projects to one another to identify which will likely have the higher return. Net profit margin is how much profit a company makes. Finally, cost-per-hire is a good metric to use when assessing how good the company is at attracting and retaining quality, talented employees and managers.
Understanding and balancing all of these metrics is the key to understanding how to run a profitable business.
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