To grow a successful business, it is critical that you understand what drives its financial performance and measure that on a regular basis.
As the saying goes “what gets measured gets managed and what gets managed gets done”. Sounds easy enough in theory but with the constant demands of running a business, how do we find the time to implement a performance management system for our business?
In this article we outline the key factors to consider when setting up a performance management system for your business including:
• Understanding and interpreting your financial reports;
• Designing financial indicators to measure and track your numbers; and
• Using technology to make it easy to capture and report business performance.
Understanding and interpreting your financial reports
The three key financial reports every business uses to measure their financial performance are:
• Profit and Loss Statement;
• Balance Sheet; and
• Cash Flow Statement.
The Profit and Loss Statement is the most common report used to assess the financial health of a business. This report summarises the revenues, costs and profits generated by the business each month, quarter and year, allowing owners to assess whether their business is generating enough revenue and profit to grow.
The Balance Sheet is less commonly used to measure the financial performance of a business but is equally important. The Balance Sheet is a snapshot of the company’s assets, liabilities and owner funds and its purpose is to provide a summary of what the business owns (assets), what it owes (liabilities) and its net asset position. Monitoring the working capital balances of the business, such as cash in the bank, inventories, trade receivables and trade payables, is particularly important to the financial health of the business. Actively managing inventory levels, customer payment terms and trade suppliers impacts the cash flows of the business and the pace at which it can grow.
The Cash Flow Statement is critical to measuring the financial health of a business. A profitable business can go broke if it doesn’t manage its cash. Conceptually a cash flow statement is very simple – it’s a summary of money in and money out of the business. However, managing your cash flow can be quite challenging. There are so many moving parts such as when customers pay their invoices, holding enough inventory to meet customer demands, paying suppliers and staff on time and paying your interest and debt commitments. For these reasons, managing the business cash flow is one of the most challenging aspects of running a small business.
Designing financial indicators to measure and track your financial performance
Create a forecast
Measuring your financial performance starts with preparing a forecast for the coming financial year. Use last year’s financial results as a guide and incorporate your plans for the coming year to estimate the revenues, costs and profits of the business. Forecast working capital and capital expenditures as well as funding requirements.
Profitability measures
Once you have developed a forecast you have a benchmark to compare your performance to. Compare actual results achieved for the month, quarter and year with your forecast as well as results achieved in the previous year. Identify any adverse trends or underperformance and determine the reasons for this. For example, if your revenue is down from the same period last year or less than what you were forecasting, break out the numbers to determine if it is a result of a fewer customers or less average spend per customer. Once you know the reason, you can develop a plan to correct it.
Follow this same process for these key metrics:
• Revenues;
• Direct costs;
• Gross profit margins; and
• Key overhead costs such as staff wages, operating expenses, sales and marketing and administration costs.
It is also useful to compare your financial performance against industry benchmarks. While each business is unique and may be in a different growth stage, it is a useful comparison that provides further insight into your business performance.
Balance Sheet measures
Preparing and reviewing your Balance Sheet on a regular basis will provide you with the information you need to manage your assets, liabilities and cash flows. Analysing your Balance Sheet will help you answer questions such as:
• Are we carrying too much stock?
• Have our customers paid us on time and who do we need to follow up?
• What do we owe to trade suppliers and the tax office?
If you provide time for your customers to pay their invoices, then reviewing an aged receivables report on a regular basis is essential to identify customers that are outside their agreed payment terms and need to be contacted.
Likewise, you should review an aged payables report on a regular basis to ensure you pay your suppliers on time. Some suppliers offer discounts for on-time payments and failure to pay your suppliers on time may result in non-delivery of stock or late payment fees being charged.
Cash flow measures
Most business owners measure their cash flow by the amount of money they have in their bank account. But simply measuring the amount of money you have in your bank account won’t enable you to manage and forecast your cash flow, which is essential to ensure your business is viable and can sustain its growth.
To measure the cash flow of your business and understand how to manage it, you will have to prepare a Cash Flow Statement that allows you to see where the cash is in the business. Is it tied up in the working capital of the business? Have you used cash to purchase plant & equipment? Or have you used it to pay down debts and loans from shareholders?
Being able to see where the cash is in the business allows you to better manage it. For example, perhaps your accounts receivable balances have increased beyond the standard 30-day term due to unpaid customer accounts. If this is the case, the action plan is to contact these customers and make a payment arrangement. Perhaps a customer cancelled an order unexpectantly and you are now carrying too much inventory than budgeted for. Discounting the stock and advertising sale prices is a quick way to get the stock off the shelf and cash in the bank.
Using technology to make it easy to capture and report business performance
With the advent of cloud-based technologies, it has never been easier to measure and track the financial performance of your business. Using accounting and bookkeeping programs such as Xero (www.xero.com), businesses can view their financial results in real time and keep track of their performance.
Sounds easy, in theory, but with so many demands on our time, implementing and managing a financial reporting system can be a challenge for most small business owners.
VBA has solved this problem by developing a financial reporting program called My Business Brain.
Using cloud technology, we extract the financial data from your accounting software and provide you with the information and insights you need to measure and analyse your financial performance. We meet with you each quarter to interpret the results and discuss strategies that will improve your profitability and cash flows.
There's a lot to consider when growing your business - but you don't have to figure it out alone. Reach out to VBA today and take your business to the next level.