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February 23rd, 2016
If you can’t measure it, you can’t control it. If you can’t control it, you can’t manage it and improve it. Businesses are flooded with an overload of information and data. So what should we measure?
My approach to performance measurement is to keep it simple and focus on the indicators that matter the most. Measurements should be action oriented to help businesses make better decisions and at the right time. This requires an accounting and financial information system capable of providing the right information on a timely basis.
Measurement starts with a strategy, goals, and plans. Knowing where you are going and what’s needed to get there is critical. This is where most small businesses fail to do a good job. They need help with planning and making sense out of measurement. A good coach combined with CFO support can be a difference maker.
Metrics that matter should include:
- Cost of Goods Sold
- Gross Margin
- Quick Ratio
- Debt to Asset Ratio
- Days of Sales in Accounts Receivable
- Payroll/Number of Employees
Tracking trends on these top 10 metrics and comparing performance against forecast and goals is the key to small businesses survival and success.
All the above measurements matter, but cash is king. Cash starts with converting more sales leads into sales because it is critical to increasing cash flow. Once you make the sale, it’s time to get paid, and the faster the better. Since many businesses sell on terms of 30 days, closely monitoring accounts receivable and the number of days sales outstanding is one of the key components of cash conversion efficiency. The faster or fewer number of days sales outstanding, the better.
You need to purchase materials or goods that are recorded into inventory before converting them into sales. The more effectively you turn your inventory into sales by reducing cycle time is crucial. Your cash conversion is determined by combining the average number of days cash is tied up in accounts receivable plus the average days cash is held in inventory less the average number of days of payables. The fewer number of days contained in the cycle the better.
The faster your cycle time, the faster you will convert your sales into cash. A component in achieving faster cycle times is to reduce the number of days required to send out your sales invoices after goods have been shipped or services rendered.
Monitoring profit margins is another element of keeping your business healthy. Tracking the trend of sales, expenses, and cash using diagnostic dashboards is something every business should be doing on a monthly basis.
Virtual CFOs can be a big help to small businesses in measuring and monitoring performance because they know how to use cloud-based dashboard tools and charts to point out the areas where improvement is needed. They also understand the relationship between key measurements and how they impact performance. Having monthly performance measurement reviews should be a ritual for every business as they can represent the difference between success and failure.