Brian owns a professional services business in Bellingham that has 12 employees and has been in business for over 12 years. He has been impacted by the declining economy with reduced sales, more bad debts and the inability to pay his bills. He came to the Center for Economic Vitality for help in getting a bank loan to help meet his cash flow challenges. It quickly became apparent that Brian’s business didn’t qualify for a bank loan and was on the verge of closing their doors in less than four weeks if something drastic wasn’t done. Brian was frustrated with the lack of current and accurate financial statements from his bookkeeper and didn’t know how to get the company out of this mess.
Betty runs a small manufacturing company with 15 employees and over $1.2 million in sales. Her business has also been impacted by the economy, but she is making daily and weekly corrections to her business, so she remains profitable with the ability to pay her bills by focusing on cash management and key performance indicators (KPIs). Betty’s business is surviving because she is aware of what her business is doing each day, what the business needs to do, and she has planned for contingencies. The key to her success has been developing early-warning signs and KPIs for all of the operations in her business.
How do you know if your business is in trouble? Do you have ways to measure your company’s performance? Have you done contingency planning that focuses on what if sales decline, costs increase, labor costs get too high, your bank won’t renew your line of credit, or you can’t pay your bills? During this challenging economy, businesses need to be more proactive in their planning and monitoring the company’s performance than ever before. So how does your company manage performance proactively?
Most owners manage their company based on their financial statements. A profit-and-loss statement shows how much profit a business is making, what the gross-profit margins are and what sales have been for the period. A balance sheet shows cash position, money in the bank and the ability to pay bills. The problem is most companies generate financial statements once a month and usually 2-6 weeks after the month ends. But even if the financials are accurate, there is a major time lag between when a company’s actions (production, sales, purchasing, etc.) occur and when the financial statements come out. It can be up to two months before an owner is able to recognize a problem and can even start to deal with the solution.
In today’s fast-paced world and challenging economy, managing your business strictly from financial statements is an early-warning sign that you’re in trouble. Instead, more accurate and timely information is needed to survive and thrive.
Developing KPIs is critical during poor economic times. It is critical that the owner/manager knows how the company is performing each day and in each operating area. KPIs are the best way to monitor your business. Some examples of KPI are:
- Break-even: Break-even analysis is one of the simplest yet least used analytical tools in running a business. It helps to provide a dynamic view of the relationships between sales, costs and profits. Break-even is that point when sales equal the total costs necessary to run the business (the business no longer has losses nor profits). Break-even can be expressed as a volume of sales (dollars) or units of sales over a period of time (year, month, week or day).
- Sales KPI: Monitoring the revenue generation of the company can be done in many ways: sales/ day (week or month); average dollars / transaction or invoice; customers/day; prospects/day; % of bids awarded vs. bid; phone calls inbound and outbound; top 20 customer list with itemization of who fell off the top 20 list from last month; create daily, weekly and monthly sales goals by cost center or product line.
- Labor costs: Labor expenses are typically the largest and most controllable cost small businesses face. They are also the most frequently ignored cost. KPIs include: labor costs to sales ratio by cost center or by hour to determine labor allocation and scheduling; total labor costs versus industry standards.
- Accounts receivable, accounts payable and inventory turnover ratios: In a tight economy people take longer to pay their bills, causing your accounts receivable to balloon and your business to have a shortage of cash. Accounts payable turnover (how fast do you pay your bills) is also an indicator of cash management. Without close monitoring, inventory levels will continue to rise when sales slow down, causing more of your valuable cash to be tied up in inventory and causing your inventory turnover ratio to increase. Managing these key areas of your business is even more important during hard times.
- Variance reports: How do your sales and expenses compare to the same period last year? How do your actual sales and expenses compare to your budget? Can costs and revenue be broken down by product category or department?
Each of these indicators helps the owner manage their business in real time and allows for adjustments, cost-cutting measures and informed decision making. Tracking these indicators doesn’t have to involve complex spreadsheets or lots of time. Keep it simple, develop targets, understand how you compare to industry standards, and track some of these indicators by hand, plot them on a graph to track trends and changes over time. Most of all, develop these KPIs for your business now. KPIs will become the early warning signs that your business needs to adjust to, before you get into trouble and your options become limited. If you need help or further resources on developing KPI or early-warning signs for your business, call the Center for Economic Vitality for more information or a free business consultation.