Survival of the Fittest: Protect Your Business From Financial Failure Through Key Performance Indicators
How confident are you about the financial viability of your business or not-for-profit organization? According to the SBA Office of Advocacy, about two-thirds of small businesses with employees survive at least 2 years and about half survive at least 5 years. Only one-third survive 10 years or longer. These statistics should be a wake up call – to invest the time in assessing your financial operations.
How can you increase your odds of surviving? You may be regularly producing financial statements, but do you really understand what the data is telling you? Just generating the numbers isn’t enough. You need to leverage your financial information in order to not only survive, but also thrive in our volatile business environment.
Tone Up by Zoning In on Key Performance Indicators
Key Performance Indicators, or KPIs, are ways to measure how you’re doing in areas important to your organization. KPIs help you evaluate your success in achieving targeted objectives. Your business/not-for-profit should have KPIs that cover all integral aspects of the business, such as:
• Strategic KPIs (e.g., metrics on customer satisfaction, program effectiveness)
• Operational KPIs (e.g., metrics on marketing and sales, human resources)
• Financial KPIs (e.g., metrics on profitability, cash management, expense control).
This article focuses on Financial KPIs; however, the same principles apply across all areas.
Why are KPIs important?
Financial KPIs help you make decisions based on supportable data, whether it’s deciding whether to expand your programs, hire another staff person or raise prices on your products/services. You may inherently feel that your business is running smoothly, but you can gain a lot more comfort on your long-term viability by analyzing financial metrics regularly and gauging how you’re faring compared to other similar businesses. Further, creating, tracking and monitoring KPIs can help you and your staff focus on areas you need to improve, and can help assess your progress toward established goals.
Here’s a suggested roadmap to start you on your way to financial fitness using KPIs:
• Identify Financial Areas of Importance – Think about what matters most to your organization from a financial perspective. If you’re just starting out, keep it as simple as possible in the beginning and identify only a few KPIs (for example, no more than five). Remember, the goal is to provide a disciplined FOCUS on improving your financial health. Therefore, avoid taking on too much at one time.
• Define Your Metrics – Once you’ve figured out important financial focal points, you can then create specific metrics to address them, and start tracking them.
For example, let’s say Profitability is an area of financial focus. There are several metrics to consider. One example would be to track your Gross Profit Margin Percentage on a monthly basis. Gross Profit Margin is a measure of the proportion of revenue that is left after deducting all costs directly related to services and sales. The Gross Profit Margin serves as the source for paying operating expense (such as rent and other administrative costs); having a higher one facilitates a stronger net profit for you.
To calculate your Gross Profit Margin Percentage, you take your Gross Profit (which is Total Revenues minus Cost of Goods sold), then divide the result by your Total Revenues. To get the percentage, multiply that number by 100:
[(Total Revenues – Cost of Goods Sold)/Total Revenues] x 100
• Understand Your Status – Understand the historical and current status of your KPIs by calculating the metrics using data from your accounting system and financial statements. So using our above example, let’s say you’ve been in business for two years and you’ve calculated your Gross Profit Margin Percentage as follows:
You now have an understanding of your overall profitability and can compare it against industry standards to get a feel for where you stand. If you’re overall Gross Profit Margin Percentage is significantly below industry benchmarks, you can delve into the details further, by analyzing the Gross Profit Margin Percentage for each major service type and product line. This will help you see where the outliers are. This knowledge helps you to set a course for the future, which is the next step in the process.
• Establish Clear Objectives and Strategies for the Future – Knowing where your organization stands in terms of your KPIs can lead you to taking a proactive and focused approach to improving your future. For example, in our Illustration above, if your goal is to improve your Gross Profit Margin Percentage by the end of next year by at least 3%, you should consider adjustments to either your prices, the volume of clients/customers served, and/or lower the cost of goods and services sold. It may take time for such adjustments in strategy to take hold, but by tracking your KPIs, you’ll have the tools to facilitate a thoughtful approach.
• Monitor, Evaluate and Adjust as Needed – Now that you have KPIs to track and goals for where you want the results to be in the future, establish a regular process for reviewing and evaluating the results. For example, after the monthly books are closed and your financial statements are generated, a good process would be to review your KPIs in conjunction with your financial statements. As part of this step, you’ll want to assess whether your strategies are working or not, and adjust as needed. Also, don’t be afraid to refine your KPI metrics if they are not meeting your needs. Remember, it’s better to start the process and make changes as needed, than to avoid taking any actions for fear of making mistakes.
There is a wide range of financial KPIs to choose from, covering areas such as Profitability, Cash Flow, Liquidity, Growth, and Efficiency. What’s important may vary from across businesses. However, here are some common examples of KPIs for you to consider tracking monthly:
• Cash Flow – The amount of Cash received, minus the amount of Cash paid.
• Accounts Receivable Days – How long it takes to collect the amounts due from clients/customers.
• Inventory Turnover – The number of times you’ve sold and replaced inventory.
• Operating Profit Margin – The proportion of revenue that is left after deducting all operating expenses.
• Revenue Growth – The percentage change in revenue.
Other Best Practice Considerations
As you gain more experience with using KPIs to assess and manage your financial fitness, consider ways to enhance the process. You may want to involve your staff team in the process. At a minimum, to the extent your staff’s actions have an affect on the metrics, they should be aware of what the KPIs are and their importance, and how staff can aid in making established targets. Some businesses even tie staff bonuses to attaining certain KPIs.
As your process matures, you may consider creating a KPI Dashboard Report that enhances your ability to review and analyze your KPI data. For example, there are apps, such as FATHOM, that integrate seamlessly with QuickBooks and other accounting software, allowing you to create dynamic reports without having to manually enter in your data and calculate your metrics; the app does the work for you.
“You can’t manage what you don’t measure” – Peter Drucker (leading management consultant/expert)
Take charge of your financial fitness and avoid the path of failure experienced by many other small businesses. By identifying Key Performance Indicators to measure, track and monitor over time, you’ll strengthen your practice’s ability to not only survive, but prosper!
Questions? Need Help?
If you have questions and/or would like to understand more about KPIs and how they can help your business or not-for-profit organization, please reach out to me, I’ll be happy to talk with you. Orin Schepps, Founder and CEO @consultanceaccounting http://www.consultancellc.com