People have a need to understand how a business is performing at any given time. Business managers, CPAs, lenders, business valuation experts and potential investors all use metrics that provide critical insights in making their particular assessment so they can reach certain conclusions about a business. For business owners, the time savings and avoidance of lost profits due to poor decisions are a key reason for consistently using metrics to assess their business. The first source of information providing an insight into business performance is the financial statements (P&L, balance sheet and statement of cash flows). From appropriately prepared financial statements, a person can gain numerous insights about the business by employing several typical metrics that focus on business profitability, cash flow, liquidity, leverage (debt), equity, capital expenditures and so on.
Where Metrics are Used
How do metrics really help a business? In using the P&L as an example, specific metrics will be able to identify cost issues in the operation and in the general and administration section relative to sales volume. Three metrics that are typical for this purpose is the gross profit margin (essentially measuring cost of goods sold), operation profit margin (measuring general and administrative expenses) and net profit margin (focuses on non-operating expenses like interest expense). Over time, managers know their margins and can immediately identify where costs are unmanaged. Similarly, there are metrics that are applied to the balance sheet that identifies cash flow issues, procurement issues, and capitalization issues among others. There are metrics that use information off of both financial statements that can provide insight, too. For example, days sales outstanding computes how long customers are taking to pay their invoices and when compared to the invoice terms can identify a liquidity issue.
Metrics provide valuable information from their trends. There are numerous insights about a business that come to light when metrics are viewed on a trendline which can expose issues of business mismanagement that otherwise would be overlooked. Is inventory growing when sales are declining? Are certain costs (particularly variable costs) growing relative to sales where such costs should remain relatively static? Is liquidity shrinking due to line of credit use and less cash in bank? If so, why? Regular use of metrics will provide timely information to take corrective action before a problem becomes a big problem.
Customizing Metrics and Incentives for Your Business
Metrics can be customized for a business. Customer service, production output, services measurement, cash management, inventory management, scheduling and on and on aids in seeing issues arise before you see the impact on a financial statement. These proactive measures can also be used as targets to develop specific incentive programs for the team members responsible for those specific areas. Such line-of-sight incentives go a long way to maintaining the team’s focus on their tasks which in turn benefits the company.
If your or your client’s business is lacking metrics, it is not too late to build a set that makes sense for measuring the health of the company and the ongoing activities it is engaged in. Historical information will help develop the trends that provide key insights into various areas of the business as well as give managers the walking knowledge of how the business performs and evolves over time. As the key metrics are identified and aligned to the overall goals of the company, internal issues can be quickly identified and the cost impact therefrom contained. Such discipline is typical of solid businesses.
The CFOs at CFO Spectrum have extensive knowledge in building a set of metrics that is customized to a particular business in way that is meaningfully usable within the organization. Do not hesitate to talk with us by contacting us at cfospectrum.com.