Mike Iverson’s client had it all figured out. He knew exactly how well his business was doing every month, without researching complicated data or paying an expensive consultant. He just looked at his phone bill. If the number of outbound calls was up, he could bet that his revenues for that month would be up, too.
A reckless, haphazard guess? Just the opposite. Iverson’s client had found a simple metric that he could track every month and immediately gauge the health of his business.
The concept of a simple metric as a forecaster of financial health belongs to Norm Brodsky, a successful serial entrepreneur and writer for Inc. magazine. The idea is for every company to find that one magic metric – the connection between a routine business function and the positive growth of a company.
“I think every business has it,” says Mike Iverson, CPA and principal of Trillium Financial. “Every small business can put a finger on a certain key number that can tell you how you will end up that month.”
The trick, of course, is uncovering exactly which numbers have that relationship in your business. For example, if call volume goes up and sales go down, you’ve got the wrong metric. It is important to track as many numbers as possible in the beginning, because it may take two years (or more) to find the leading indicator. Also, recommends Iverson, track the numbers by hand. The process of writing the numbers down with a pencil and paper will help you realize the connections.
Here are seven important metrics for any business. Track them for 3 months and see which one gives the greatest transparency to the rest of your business:
- The Trailing 12-Month Sales Average: By monitoring – and graphing – sales from the 12 months prior, you’ll get a visual of the progress of sales, while taking seasonal issues out. If it’s July 2020, look at July 2019 through June 2020. Graph each month’s sales and see where the highs and lows were, and what the average was. If that 12 month average is trending up, it’s good. If the graph line is flat or declining something is causing sales not to perform.“If you look at just sales numbers month to month, you won’t see it,” says Iverson. “This is a visual metric: you want to see that 12-month trailing graph trending up.”
- Operating Profit Percentage: This shows the extent to which a company is making a profit on standard operations. When looking for indicating factors, ask, ‘Is this percent holding steady, increasing or decreasing?’ You can also examine this on a trailing 12-month average.
- Accounts Receivables Cash Conversion Cycle: If you extend credit to customers, track how long it takes to collect cash from the time the bill is sent. What is your cash conversion cycle (or DSO – Days Sales Outstanding)? Be careful about the terms extended to your customers; you have set them for a specific reason. If customers go beyond those time limits, you’ll feel the pinch.
- Days Inventory Outstanding (DIO): In theory, you should keep the least amount of inventory on hand as possible. In a perfect scenario, you would get the order in just in time to have it manufactured and sent out; the longer inventory sits unsold the more of a drain it is on your cash.
- Disbursement Cycle: These are the terms you get from your vendors. The longer you can hold on to your money and the faster you get it from your customers, the better.
- Working Capital as a Percent of Your Revenue: This is an important financial set of measures to look at because it is often overlooked by business owners, says Iverson. “They know to look at the income statement. But if all that operating profit is getting absorbed into working capital, then there won’t be enough cash flow to grow the business,” he says.Receivables and inventory are investments. (And in the same way vendors have an investment in you.) You’ll want to invest as little as possible of your revenue in working capital. Turn your receivables to cash, your inventory into billing, and hold on as long as you can to your money. Look at the number of days net working capital is invested every month (or cents on the dollar of what’s invested). If you don’t have enough cash flow to cover what you’ve got invested, you’ve got a problem.
- Return on Capital Employed (ROCE ) Percent: According to FinanceScholar.com, ROCE measures the efficiency and profitability of a company’s capital investments. For example, capital assets such as trucks and computers should help make the business more efficient, cut down on costs and realize greater profits. The ROCE percentage also indicates whether the company is earning sufficient revenues and profits in order to make the best use of its capital assets. The higher the percentage the better.
Tracking the numbers involved with these seven metrics over a period of time will give you an idea of which is the leading indicator for your business.
“It seems like the concept would be complex, something more to it. But really there’s not. If you break it down and keep it simple, the metric can give a business owner an easier way to digest information and act,” says Iverson.
Start measuring today so you can figure out what actions to take in order to achieve your financial goals. Trillium Financial can help; just contact us at (404) 353-2148 or [email protected].