Measuring to Manage Growth in Profitability - Part 1
Profitable growth is what most businesses rate as their main priority right now. To manage this properly, we must know what to measure. There are two keys areas that need measurement. What has already happened that we can learn from (historical KPI’s) and activity measurement that will help influence future results (Future performance KPI’s). Let’s firstly deal with historical KPI’s.
Most business owners measure growth in sales and are excited by higher results. High sales are often confused with success. Sustainable success only comes from generating growth in profit and it is increased profitability that generates more cash, pays for assets and ultimately generates wealth. To ensure profitable growth the measurement of the Key Performance Indicators (KPI’s) of your business is critical.
KPI’s are identified in two ways; those that measure historical performance and those that measure the future performance.
Every business must focus on the KPI’s that will show how the business is performing and identify areas where potential problems could occur.
Typically most advisors will deal with the historical and projected financial information of your business. The following areas should in most cases, be the focus of historical monthly reporting and management review.
Historical Performance KPI’s
1. The Pareto Principle!
It is a well-known fact that in nearly every business, you’ll find the Pareto principle at work. It is also known as the 80/20 rule and when analysed, you will find that approximately 20% of your customers give you 80% of your sales.
Similarly 20% of your product/service range will give you 80% of your income.
The 80/20 principle applies to nearly every aspect of your business and the key is to identify those products, services and customers that generate the major contribution to your profitability.
Once analysed, use this information advantage. The 80/20 rule will show you which customers to spend time with and which products or services are the foundations of your business. This results in more efficient use of your time.
2. Sales - by product, by salesperson, by day, by week, by month
Sales by products will tell you which products sell best and worst. If you’re putting all of your effort into products that are the hardest to sell, perhaps you need to rethink your sales strategy. You may want to package them with fast moving products, organise special offers for them or perhaps drop them from your product line altogether.
Sales by salesperson will tell you how your sales team are performing. It may highlight problem territories, training deficiencies or just perhaps problem sales people. Targets should be set for all sales people and a weekly meeting with them should identify why targets aren’t being met. (Try the “what can we do to help you achieve targets” strategy, not the “you need to do better or you’re out” when addressing your sales people).
Sales by day, week and month will tell you the peaks and troughs in your business and help you to plan your marketing efforts to increase sales during down periods.
3. Gross Margins
What are the margins on each product and overall sale per product? Are you spending too much effort on products that have low gross margin? If so, cut them from your product range, or increase the prices. Concentrate your efforts on the 20% of your clients that give you 80% of your gross margin.
4. Debtor Payment Ratio
How long do your customers take to pay? A debtor stringing you out for 60 days can cripple your cash flow. Several doing the same can cause considerable financial pressure. Put in place a debtor collection system and insist on the terms of payment of your business.
5. Stock turn and Stock Levels
How much stock do you hold on average at any one time and how often does it move in a year? If your stock is sitting on shelves it is not making you money. If you’re holding too much stock, you’re robbing your cash flow. If you have old stock sitting there not selling, sell it at a discount it and generate cash.
6. Creditors Terms
How your suppliers trade with you can also be an important measure. Local suppliers, and some overseas suppliers, offer payment terms and this is often viewed as cheap funding.
Stringing out creditors, however, can often reduce your ability to obtain the best prices and impacts gross margin.
7. Working Capital Cycle
Working capital cycle measures the time between paying for goods supplied and the final receipt of cash from the sale. It is desirable to keep the cycle as short as possible as it increases the effectiveness of working capital.
8. Performance to Budget
Like cash flow, you should have a sales & expense budget prepared for your business at least once a year.
A budget allows you to work out what your expenses will be and what levels of sales will need to be achieved to cover them and generate the required profit.
Budgets should also be set for sales (sales targets), marketing and purchasing and these should be monitored weekly and monthly. Monitoring allows you to identify under-performance or overspending you are able to find a solution before it becomes a problem.
9. Comparatives and Benchmarks for your Industry
Have you ever wanted to know how you should be performing? What your competitors are doing? How you compare? Did you know that these figures are available and will give you an insight into how your business compares to your competitors?
KPI’s of your industry group are generally available from nem or your business advisors. The ATO also publishes some KPI’s on it’s website.
They will give you valuable insight into the measurements you should be taking and what results you should be getting to compete in your marketplace.
Your advisor is skilled in all these areas and can not only assist with the implementation and regular reporting of financial results. They can help you establishment and implement the systems and procedures you required to gain accurate reporting of your business.
10. Period Comparison of Financial Performance
Apart from comparison of progress against the current year financial budget it is useful to compare current month and Year to Date (YTD) performance with the same period from the prior financial year. This is particularly useful for business that may experience revenue seasonality. Period comparisons with the same period in the prior year tend to accommodate any seasonality effects and gives one a good idea of whether the business is performing ahead or behind of last year.
Want to know more?
Check back for Part 2, which covers Future Performance KPI's;
- Cash flow
- Conversion rate
- Repeat business
- Average dollar sale
- Measuring marketing output, and