Experienced small-business owners will probably agree on one business maxim: We manage what we measure. You should understand which numbers or ratios are critical in your business and industry and manage, monitor and adjust your business plans and models around them. For example, if your most critical number is inventory turnover, you probably have an app on your smartphone that you monitor daily. You should also know the impact and “ripple effect” when these numbers are above or below targets or expectations.
Get into the discipline of producing reports and reviewing the results with your board of directors or advisory board and your team's key leaders (to the extent you're comfortable sharing financial information with employees). Consider also establishing a relationship with a coach, mentor or consultant with whom you can discuss key numbers candidly and confidentially.
The profit and loss statement often tells the most important story of how your business is performing. This is where the results of your company’s efforts, successes and challenges are articulated from a numeric perspective. However, many small-business leaders may not focus as intently on the balance sheet and what story it's telling—assuming there isn't a more immediate liquidity or solvency problem.
Every business has a series of key performance indicators (KPIs) that serve as critical numbers to be maintained and measured. A KPI is a performance measurement tool you can look at daily, weekly, monthly, quarterly, annually or on a project-by-project, office-by-office or division-by-division basis to help measure and predict the overall health and efficiency of your financial and overall operations. Effective use and interpretation of your KPIs can help you define and measure progress toward your goals; make informed decisions on budgeting and resource allocation; avoid being blindsided by weak results; detect fraud, pilferage or inefficiency, and face lenders or investors with confidence.
Here are seven critical numbers you should manage:
Accurate sales figures can be the first indicator of business trends—whether increasing, decreasing or flatlining, they can provide an indication of where the business is heading, but should be monitored in conjunction with bottom-line performance. Many small-business owners become too "top-line" focused and take false comfort in knowing that sales are growing, even though margins may be shrinking.
2. Cash Flow Forecasts
Calculate your cash flow forecast on a weekly or monthly basis—more often is better, especially during a growth spurt. The calculation is: Cash in the bank, plus cash coming in over the next four weeks, minus cash going out over the next four weeks. This indicates any cash shortfalls over the next four weeks and the ability to pay your bills at the end of the month.
3. Debtor Days Outstanding
This equals the average days it takes customers to pay your invoices. The calculation is: Accounts Receivable/Sales x 365. A decrease is a positive sign, while an increase can be an issue, as it may impact your cash flow and ability to keep your creditors current.
4. Creditor Days Outstanding
This is the average number of days it takes you to pay your suppliers. The calculation is: Accounts Payable/Purchases x 365. This should be monitored in conjunction with your debtor days; ideally, you want your creditor days to be equal or higher than your debtor days. If it's lower, you should improve your debt collection, reduce your customers' credit terms or negotiate better payment terms with your suppliers to avoid cash flow problems. This is one of the critical disconnects that can cripple a small company.
5. Inventory Days or Stock Turnover
This measures the average days the inventory you produce or purchase remains in your warehouse or on your shelves before you sell it. The calculation is: Inventory/Purchases x 365. The lower the number, the better for your cash flow and ultimately your ability to grow your business and expand your customer base without straining resources. Inventory that's "collecting dust" costs you money and may be stale or obsolete. Carefully monitor what's moving and what's sitting, and understand why. Stay close to the customer and meet often with your sales team to analyze and discuss any inventory stuck on your shelves.
6. Gross Profit Margin as a Percentage of Sales
The percentage indicates the price you charge your customers against the prices your suppliers charge you. An increase is generally a good key indicator, but a breakeven point or decrease should alert you that flaws exist in your business model or that overhead is too high or prices too low.
7. Profit Before Income Tax as a Percentage of Sales
Ideally, this figure should increase—a flat line may be acceptable for a period, but a decrease is a warning sign of further losses.
Once you decide on your critical three to five numbers, digest them on a daily basis, just like your morning coffee or vitamin regimen. Depending on your culture and leadership style, you should share these numbers with employees and make them the basis for daily huddles, brainstorming and longer-term strategic planning. These numbers can also form the basis for employee-level rewards and bonuses to drive business growth and achievement of business goals.
The information contained in this article is for generalized informational and educational purposes only and is not designed to substitute for, or replace, a professional opinion about any particular business or situation or judgment about the risks or appropriateness of any financial or business strategy or approach for any specific business or situation. THIS ARTICLE IS NOT A SUBSTITUTE FOR PROFESSIONAL ADVICE. The views and opinions expressed in authored articles on OPEN Forum represent the opinion of their author and do not necessarily represent the views, opinions and/or judgments of American Express Company or any of its affiliates, subsidiaries or divisions (including, without limitation, American Express OPEN). American Express makes no representation as to, and is not responsible for, the accuracy, timeliness, completeness or reliability of any opinion, advice or statement made in this article.
Andrew J. Sherman is a partner in the Washington, DC, office of Jones Day, an adjunct professor in the MBA program at the University of Maryland and Georgetown University, and the author of 26 books on the legal and strategic aspects of business growth and capital formation.
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