In an earlier article, I wrote about how the measurement of your business success should include qualitative measures as well as quantitative benchmarks.
I received a lot of email to ask about what quantitative metrics I thought were important in business. Now, I repeat what I said earlier, first, that qualitative metrics such as customer satisfaction and service delivery times can be just as important as quantitative measures. Secondly, that you need to define what you mean by success before you can choose the appropriate measures.
Having said that however, I thought I should deal with all those emails and provide a discussion on the types of quantitative measurements you might want to employ.
Howard from Sydney asked what might be some warning signs to watch out for.
Here are some quantitative metrics from your profit and loss account that can show your business is needing attention:-
- Increasing sales but declining profits (margins dropping)
- Steady and stagnating sales levels (no growth)
- Increasing sales and increasing interest costs (are you funding your debtors or “over-trading”?)
- Increasing fixed expenses (means possibly increasing break-even point)
- Increasing expenses as a proportion of sales (when did you last review your prices?)
- Increased cost of goods sold (have you passed on price increases?)
- Profit percentage not up to industry averages (why not?).
Pat who runs an art supply shop in Manchester asked for a list of financial ratios he could review. Bearing in mind that you need to choose the metrics that are relevant to you, here are a few to look at:-
- Gross profit as percentage of sales
- Net profit before interest and tax as percentage of sales
- Financing costs as percentage of sales and of total expenses
- Salaries as percentage of sales and as percentage of total expenses
- Occupancy costs as percentage of sales and of total expenses
- Increase in sales on last period
- Return on Investment or on Capital employed.
Pat, don’t forget to turn your attention to your balance sheet as well. How your assets and liabilities perform is also important for the overall health of your business:-
- “Quick” ratio (Cash to Current liabilities)
- Current ratio (Current assets to Current liabilities)
- Long term debt to capital ratio
- Days in receivables
- Days in Payables
- Days in inventory.
Ratio analysis is not the end in itself. Once you work out your ratios or percentages you need to compare them first against past periods to determine trends, and then to industry averages to determine competitiveness. The key is in asking yourself a series of questions, starting with why the trend is the way it is.
Siti in Kuala Lumpur asked what she could do if after analysing metrics she’s still not hitting her desired benchmarks. Often, it’s a case of trying one solution after another, however in some instances, you may have to reverse engineer your targets. Siti, given the example you gave me, one way of doing this is to ask yourself how much discretionary expenditure is in your figures. For example, if advertising is above your industry norms, what proportion of your advertising expenditure is discretionary and how much is critical to retain and grow sales? Once you are able to understand that, you may then be able to set appropriate levels of expenditure and then work out what your “norms” are for each given measurement, and keep tweaking it until you get to a profit and sales figure you are comfortable with.
Another area you need to keep an eye on is your cash flow. Some of the balance sheet metrics mentioned above will give you an idea of the health of your cash flow. For example if sales is growing and profit is not; while aged receivables are growing, then clearly cash flow is tightening. Inventory, slow payers, unduly high loans, are all potential roadblocks to good cash flow. Always have a plan B in case things don’t go to plan.
Finally, with the appropriate caution I started with, that qualitative measures are just as important and that any measure should be appropriate to your circumstance, it is important to state that taking the time to regularly review your financial statements and work out your key financial metrics is an important process in building (and protecting!) your business. This is even more important in difficult times when forecasts about growth and sales are uncertain. You should be working to grow your business, but be aware that you may need to save it too.
Go to https://teikoh.com and you will find resources to measure key benchmarks. Register your name and email and I will send you more valuable (but free) tools and resources from time to time.