I drove by a billboard recently that advertised the “5,000 homes sold” by a local real estate company. It reminded me of awards that businesses can win for “fastest growth” based on revenue. These claims are missing important context.
Volume, revenue or sales activity alone are not indicators of true business health. Revenue is, of course, the top line of the math equation that results in net profit, but there are several other pieces to that equation that are critical.
Key performance indicators add context to your business story. There are several measurements for profits, liquidity and efficiency that indicate the long-term sustainability of a business. Some common KPIs may include:
- Current ratio – Do you have enough liquidity to meet your current obligations if you had to close the doors, even temporarily, today (like in the case of a global pandemic)
- Gross margin – Is your product or service actually profitable?
- Accounts receivable turnover – How quickly are you collecting payments from customers?
- Labor utilization – How efficient and productive are employees compared to your labor costs?
- Debt to equity ratio – How much debt are you accruing to finance growth compared to funding growth with profits?
- Inventory turnover – How quickly is inventory moving out the door?
- Working capital – What is the status of your accessible liquid assets?
These common KPIs add context to your financial statements to indicate any outliers or significant changes. By viewing your growth and activity in light of several KPIs, you will start to see trends. This helps you to adjust more quickly to avoid financial problems.
For example, you may notice that A/R is creeping into the 60-90 day aging buckets. Investigating further, you can identify customers that require more follow-up or you can set up more timely payment terms and collections practices.
Or, you may realize that some employees are achieving much higher labor utilization than others – what could you learn from that?
Dive deeper into KPIs for business growth
Your accounting software may be equipped to monitor many KPIs, but try to establish five to seven solid KPIs that are important to your goals as a starting point. Once you identify trends in these baseline reports, you can dive more deeply into the data by line of business, by vendor, department or employee.
- Line of Business (LOB) revenue vs. target – To budget more accurately by line of business or department, you can track LOB actual revenues compared to projections.
- Line of Business (LOB) expenses vs. budget – Identify creeping expenses in procurement, productivity or sales more easily by viewing LOB expenses monthly and comparing them to budgets.
These examples demonstrate the power of data to build a better picture of business health. The beauty of KPIs is in their customization and monitoring over time. You can set up many different reporting scenarios that match your regular and “stretch” business goals. Monitoring KPIs not only helps you run a more efficient and profitable business, but this monthly practice can also help your advisors identify new areas of growth and efficiency. You can also benchmark against your historical results or industry/competitor numbers. Just make sure you’re really comparing apples to apples.
As an auditor, I appreciate having access to financial statement trend analysis to support more efficient testing and understanding of business health. Showing that certain expenses went up because of X, Y or Z (or A/R collection time went down because the customer changed their payment process) can reduce questions and red flags from an audit team.
The next time you see a big claim from a business about fast growth, don’t take it at face value. Think like an auditor and question the fine print found in their KPIs.