Measure Your Company's Way to Success
You can't manage what you can't see. When it comes to business basics, processes and results, numbers count, literally and figuratively. However, you can waste a lot of time obsessing over things that don't count. Here is one approach to learning what is most important to your business so you can steer your company over the inevitable bumps and come out on top.
Put Cash at the Top of the List
People going into business focus on revenue. While that is obviously important, it can be a misdirection. One of the big reasons ventures fail is they are undercapitalized. To avoid running out of money while you're trying to get the company up to speed, watch cash carefully.
"I think experienced entrepreneurs tend to protect cash balances better than early stage or first-time and second-time entrepreneurs, who are surprised about the burn rate," or the speed at which the new company spends cash for ordinary operating expenses, said Dan Gregory, director of Northeastern University's Digital Media I-cubator. "When you don't have it, $50,000 seems like a lot of money, but $50,000 when you do have it is gone before you know it."
Another aspect of cash is cash flow. That is the net gain or loss of cash each month, quarter or year. All other things being equal, maintaining a positive cash flow is optimal. But for some companies, underwriting losses while building the business is necessary. Be sure you have enough cash and credit to sustain the losses, or else you'll somehow need to cut spending or increase the speed of money coming in, either by increasing sales or possibly offering a discount for early payment. The term for a company that can't pay its bills over a long enough period is bankrupt.
Things can also get dangerous just when they seem to improve.
"Many entrepreneurs get confused by that infusion of cash [when they're finally bringing in revenue]," Gregory said. "The bank balance goes up, and you feel good about things -- and the spending immediately goes up." That is exactly when you should keep your eye on the cash numbers.
Expenses Matter, of Course
The flip side of revenue is expenses. You'll have rent, utilities, marketing, salaries and benefits and others. Watching your expenses is necessary because you can spend your way into problems, no matter how much money you bring in. Look at not only the total, but the necessity of expenses. Are you paying for space or capabilities that you really don't need?
Also keep an eye on capital expenses, suggests Gary Naumann, a former entrepreneur and former director of the Spirit of Enterprise Center at the W.P. Carey School of Business at Arizona State University. "This is a major component of cash flow that does not show up on the income statement, but is critical for many businesses," he said. "This represents the property, plant and equipment you need to run your business, but the key is how much do you need, and how efficiently are you using these assets." For example, don't buy additional machinery or equipment when you aren't thoroughly using the capabilities you already have.
Forecast the Future
Looking at sales and expenses is important, but they are lagging indicators. Depending on the type of business you're in, that can represent sales that happened a month or more prior. However, you want to know not just what happened in the past, but what is going to happen in the future. That means forecasting where you'll be next month, next quarter or in the next half-year. That means estimating revenue, expenses and the time it takes for payments to come in the door.
A key indicator is gross margins, or sales revenue minus the cost of producing the products (often known as COGS, or cost of goods sold) or services. It's the money you get to keep from sales. Gross margins are the cap on your potential success. Your margins each month should be larger than your costs of doing business.
It's a separate consideration from cash. Margins help you determine whether you're running at a profit or loss. Cash tells you whether you have the resources to pay the bills when they're due, whether or not customers have paid you yet.
%VIRTUAL-pullquote-It's that forward view I think sometimes small businesses really need to pay attention to.%John Cassimatis, president of management consulting firm TayganPoint Consulting Group, suggests also focusing on net current assets -- net receivables and net payables, or what you're owed from customers and what you owe your vendors. "If you know that you have a couple of million dollars in receivables, you should know when they should be paid," he said. Similarly, you need to know when you'll have to write checks to vendors. "It's that forward view I think sometimes small businesses really need to pay attention to."
Another part of forecasting is considering the implications of expansion. Mark Mitchell, head of small business distribution strategies at TD Bank (TD), said to look at the efficiency ratio of non-interest expense divided by revenue.
"After you project your expectations of revenue, you want to compare it to the expenses needed for that revenue," he said. If efficiency drops, you may have problems because it's costing you proportionately more to make the additional money. "If you have more operating income for every dollar of revenue you generate, you know you're pretty efficient and you're profitable."
And don't forget to monitor upcoming business. "Not only do you need to know your receivables, but you also need to know if you have enough work coming in on the horizon to sustain your business," said Jeff Kear, owner of the online planning business PlanningPod.com. "We constantly monitor what work and projects we have landed so that if there is a lull, we can ramp up sales and marketing efforts to keep those future projects and work rolling in."
If You Borrow Money ...
Although borrowing money is part of overall financials, it deserves some special treatment. The minute you take money from a relative, friend, credit card, bank or other institution, you've put yourself on the hook to repay. If you want to keep your good name and avoid legal hassles, be sure that you keep on top of the payment plan.
%VIRTUAL-article-sponsoredlinks%Mitchell said that entrepreneurs would do well to consider a number that banks pay attention to: debt-service cover ratios, or net income (money left after all expenses, including any living expenses you draw) divided by current debt payments. "What do you have after all your expenses?" he said. "Typically a ratio we're looking for is something that is greater than one, and typically we want some buffer in there, so we're looking for a buffer of 1.2 times."
For a small business, banks often do what Mitchell calls a global debt service coverage ratio. That means they look at not only your company's debt, but your personal debt. They know that, if push comes to shove, you'll keep a roof over the family's head and food on the table. Be sure to take a similar view yourself to avoid digging a hole you -- and those who depend on you -- may not be able to climb out of.
Find Numbers That Connect With Your Customers
Although financials are vital to sustainable operations, they are all about you. But business has to be all about the customer. "The mistake that CEOs make is they love tracking all kinds of data," said Greg Bustin, a business and leadership consultant. "In their effort to track so much stuff, they fail to track the two or three things that matter most."
What matters most to a business is keeping customers happy and returning.
"Figure out what is the promise you're making to your customer and how are you measuring your ability to deliver on that promise," he said. That will differ for every business and its customers. Those customers might want quick delivery or a wide selection of products. Maybe safety or quality is of prime importance. "Are we making money promising what we promise and are we delivering what we promise?" are questions Bustin said entrepreneurs should always ask themselves.
And when you have identified those metrics, make them available to people who do the related work in the company. "It's an opportunity for literally everyone in the organization to understand what are those few things that matter most to us, that help us deliver on the promises made to the customer, and do in a way that allows us to grow profitably," he said.
Watching numbers doesn't guarantee that you'll ultimately succeed. But it does help you make the best decisions possible.