Just as savvy coaches manage their teams by a set of criteria, so do savvy entrepreneurs run their businesses. Some of these standards are obvious - such as revenue, gross profit margin, and inventory value - but many others are not (or at least, they aren't closely watched). While you don't need to be a Wall Street securities analyst to run a successful small business, being adept at analyzing these numbers is crucial for both daily management and long-term planning.
Here are some examples, in no particular order:
Operating Cash Flow. Achieving net surplus is good, but cash flow is what truly matters. The former is an abstract accounting measure, while the latter reflects the harsh reality of how cash moves within your company.
The cash flow statement has a close relationship with the other two financial statements: the income statement (which records revenue and expenses) and the balance sheet (which records "working capital" items like receivables and payables). For example, let's say your company generates $1,000 in revenue in a given month, but all goods were sold on credit (meaning you didn't actually receive any cash during that time). Now assume total cash outflows for the month were $750. In this case, your income statement would show a "profit" of $250 ($1,000 total revenue minus $750 in expenses). However, your cash flow would have decreased by $750. This is because the company had to pay $750 in cash expenses but did not receive any cash from customers to offset those costs. Accounts receivable increased by $1,000, balancing the books.
Specific metrics to watch include:
Operating Cash Flow (as opposed to cash from financing or investment gains). Operating cash flow represents the amount of cash generated by the core operations of the company - essentially, the heart of the business. The formula is:
Net Surplus + Depreciation & Amortization (both non-cash expenses) - Capital Expenditures (such as new equipment) - Changes in Working Capital. Another important point about cash flow is that investment bankers often use this metric to determine the value of your company.
Inventory Turnover. The longer inventory sits on your company's shelves, the lower the return on these assets will be, and the more likely it is that the inventory will lose value. That's why you want your inventory to keep moving or "turning over." To calculate inventory turnover, divide revenue by the average inventory value during a specific accounting period. The higher the ratio (or turnover), the higher your return on invested capital. (Another way to calculate this is to replace revenue with the cost of goods sold and divide that cost by inventory; this reflects the fact that inventory is recorded on your balance sheet at its original purchase price, while revenue is calculated based on current market value.)
Accounts Receivable Growth vs. Sales Growth. Don't worry about increasing accounts receivable as long as it grows proportionally with sales. If accounts receivable exceed revenue, it means you're not getting paid, which could leave you short on cash when you need it most.
On-Time Delivery. There's nothing worse than losing a customer's trust and respect, and that happens when you fail to meet delivery dates. Delays should be marked and investigated to find out why they occurred. It might be a one-off event, but you may also discover a small glitch in the system. Like any other metric, keep an eye on delivery trends continuously.
Backlog. This week's sales might be good, but what will happen 90 days from now? Pay attention to this forward-looking metric (committed orders and forecasted sales, weighted by the probability of closing these deals) to ensure you won't get caught off guard.
Interest Coverage. Regardless of the credit environment, lenders need to know if your company consistently generates enough earnings to cover interest payments on borrowed funds. There are various ways to define interest coverage, but one common method is Earnings Before Interest and Taxes (EBIT) divided by interest expense. Banks focus heavily on this metric, so you should too. For more details on balance sheet management, check out The Entrepreneur's Most Important Asset.
Each industry (and each company within it) has its own set of key performance indicators. Choose metrics that can measure performance across surplus, debt status, and cash flow, and monitor them consistently. Keep in mind that each number carries a different meaning. Only by combining all these numbers can you uncover the fundamental principle that all smart entrepreneurs pursue: integrity.
This article is sourced from 88fa Franchise Network http://www.88fa.org/, Original link: http://www.88fa.org/post/14.html