Guest blogger and trusted business associate, Bill Boyer, is the President of CEO Focus of Tidewater, a consulting/coaching organization for small company CEOs. He can be reached at firstname.lastname@example.org or (757) 233-2577.
All companies manage “by the numbers”, but often this is nothing more sophisticated than looking at the bottom line of the Profit and Loss Statement. This is very critical, but there are many other measurements that can be used.
To get more useful information from your P&L, you should compare the current period to prior periods in the current year, and to the same period in the prior year. You should also compare the year-to-date amounts for the current and prior year. The comparison of the actual numbers may be less helpful if your sales volume is noticeably different than in the prior year (hopefully higher!). Many expenses change with volume; others do not. To better evaluate your performance when there has been a change in sales volume, calculate each line item as a percent of total sales. Those expenses that are expected to change with volume should stay fairly constant when computed as a percent of sales.
It is also useful to compare your P&L to your budget. Some CEO’s avoid doing a budget because they feel they are weak in accounting. A more accurate statement is that they don’t like accounting and may not want to be held accountable. Budgeting is not fun. It requires looking ahead, planning for the future of your company, and may highlight the need for tough choices and sacrifice. Don’t be confused, tough choices and sacrifices would have to be made even without a budget: preparing the budget just gives you the opportunity to plan for these changes. Good budgeting is part of good financial control. Budgets should be prepared on both an annual and a monthly basis. Comparing your P&L to your budget helps you track your performance against your expectations/goals, and helps you to identify the need for corrective action.
Another useful measurement that is often overlooked is the balance sheet. At times this is actually more important than the Profit and Loss. Cash is king, especially to small companies; the balance sheet shows specifically where the cash is being used. If the company is in a growth mode, accounts receivable and inventory levels are probably going up, but should not be increasing any more than the growth in sales. If these two categories are increasing more than sales, there probably is a problem. All of the balance sheet items should be reviewed, explanations must be developed for the changes, and corrective action should be taken when needed.
Beyond the financial measures, there are other parameters than will lead to managing the company objectively. Virtually everything from quality to customer satisfaction can be quantified.
The most important step in managing by the numbers is to create critical performance measures. These are non-financial data. Some examples of critical performance indicators are:
- Dollars of product produced by cost, not by sales volume.
- Utilization percentage of equipment or space
- Quality statistics
- Number of customer complaints
- Defect rate/return rate
- Inventory turns
- Number of employees by department
- Overtime hours
If the critical performance indicators are “in-line” the financial numbers will be in-line.
Kevin enjoyed a profitable business. Sales were also growing around ten percent annually. Last year, sales took a nosedive. Profitability turned to a loss. Kevin took a hard look at the expense side of the business and found that many categories of expense had “crept up” over the years. These expenses had increased so much that Kevin found it difficult to rectify all of them at once. Kevin also realized he had lost a good opportunity to “make hay while the sun was shining” by not tightly managing expenses earlier. Along with this loss, he even had a more dramatic retrogression in his cash balances as he was not managing the balance sheet.
Not only did Kevin start a formal budgeting/monitoring process, he worked with his team to come up with other non-financial performance indications that could be used as an indicator of out-of-line situations.
Some CEOs don’t like to manage by the numbers because it takes away the gunslinger approach. Cold hard numbers don’t have the adrenaline rush of the daily fire-fight. Create and use budgets. Analyze your profit and loss and balance sheet monthly. Work with your team to determine what some of the key non-financial indicators and make them a part of your business indicators. All managers must use the financial tools and other non-financial measurements to help them manage their company objectively.