My last post, Cash Is King in Small Business, discussed the importance of cash and the potential pitfalls of focusing on sales as a business metric. Growing sales can actually choke off cash and create more financial problems than it solves.
Beyond cash and sales, there are a myriad of possible measurements that business owners need in order to evaluate the financial and operational health of their companies. Without such measurements, the owner is literally flying by the seat of their pants.
One popular phrase for such measurements is key performance indicators or KPIs. For simplicity, let’s divide them into two categories – KPIs especially important to young, growing companies and other KPI’s. While this is not a definitive set, here are some example indicators for measuring the health of your company and for making better management decisions:
For young, growing companies…..
Customer acquisition cost: Marketing, sales, and other expenses required to acquire a new customer
Customer lifetime value: The total net profit received from an average customer
Conversion rate: The number of visitors to your website (or other customer generation source) divided by the total visitors
Cash flow forecast: Cash in the bank plus cash anticipated in during the next 4 weeks (example period) minus cash outflow anticipated during the next 4 weeks
Current ratio: Current assets divided by current liabilities (This is an indicator of the ability to generate cash flow and downward trending can signal coming cash problems)
Revenue versus budget: Revenue versus budgeted revenue, for a given period
Expenses versus budget: Expenses versus budgeted expenses, for a given period
Inventory turnover ratio: Cost of goods sold divided by current period inventory
Gross profit margin: Revenue minus cost of goods sold divided by total revenue
Net profit: Revenue minus expenses
Sales per employee: Total sales divided by total employees
There are lots of decisions an owner must make regarding KPIs. These include (1) which KPIs would be most important to establish and monitor, (2) what data items are currently being measured, (3) what data items not currently measured need to be measured, (4) how needed but unmeasured items can be measured in the future and (5) what actions will be taken to establish and measure the KPIs chosen.
If this looks like a lot of work to you, it probably is. However, the benefits from establishing KPIs can be the difference between a successful business and a business failure.
Don’t ignore this important factor is managing your business. Begin with what you can do and build up your KPIs as you can. Best wishes for your success.