Wednesday, September 16, 2009

Entrepreneurs Need to Know these Five Business Metrics

Imagine you own a successful business but become stranded on a deserted island.  The only communication you receive about your business comes once a week on a sheet of paper in a bottle (yes, a message in a bottle).  What information would you need and want on that paper?  When you remove the subjective elements of running a business and try to do it on objective data alone, how does that change your ability to make the right decisions?

DASHBOARD
For the purpose of this article, we will refer to this piece of paper as a dashboard report, although it may also be called a flash or KPI (Key Performance Indicator) report. The dashboard should be critical in assisting an entrepreneur or business owner predict sales, cash flow and profit and gain clarity on the performance and direction of the company.  In addition, it should be a critical decision-making tool used in the day-to-day operation of the firm that empowers CEOs and business owners to make the best decisions for their respective companies that will drive cash flow and profit.

There are three main steps to consider in building an effective dashboard.  First, we should know the averages and benchmarks for our industry.  Second, we should know what our historical performance on these same averages and benchmarks.  And third, we have to develop what many call a balanced scorecard that comprehensively examines the whole company, not just one or two parts.

SOFTWARE AND TRACKING TOOLS
The answer is not to initially buy a business metric or dashboard software program.  These tools are valuable, but every business needs to initially determine what metrics it should track.  In fact, it is always best to use Excel or even a pen and paper to initially track several different metrics. It is nearly impossible to know which metrics will be the most effective until we get some experience with it.  We can save money on the software for now and focus on finding the best metrics for our business.  Once we know the metrics that are the most effective for our business, then we can consider investing in a dashboard tool.

Marketing, sales, operations, and financial are the four main categories every business needs to include if we want the dashboard to adequately inform us on our deserted island.  We will briefly discuss each of these areas below:

MARKETING AND LEAD GENERATION
This is where it all begins.  We need leads if we ever hope of acquiring customers.  Our dashboard should include the top two to four metrics for measuring our lead generation.  These may include number of visits to our website and percentage of those visitors that become qualified leads.  The key here is to focus on the processes you are currently employing to market and generate leads and measure on your dashboard the efficacy of these efforts.  The cost of acquiring a lead should be included if it is measurable (and it almost always is).

SALES
Obviously a lead is still useless to our business if we cannot convert the lead into a paying customer.  Conversion of leads to customers is a critical element of most dashboards.  In addition, total sales should be included so we know how our volume is doing on at least a weekly basis.  Sales should be communicated in terms of dollars, number of sellable units, and average pricing.

OPERATIONAL EFFECTIVENESS
Since sales is responsible to turn the leads into a paying customers, we desire to satisfy and retain the customer as long possible as effectively and efficiently as possible.   The point here is to structure our business model so that we deliver everything we promise for as little cost as possible.  Let’s review a couple of examples.

If I am a professional service firm that is mainly selling time in exchange for services, then I am concerned about my average cost of paying staff per hour as it relates to my average revenue per hour.  I will also be very concerned with ratios like revenue per employee and sales-to-wages.

If I manufacture products, then I will want to understand the efficiency of all of my inputs, including materials (and scrap), labor, contractors, and other direct costs.  In essence, we need to look at the major determinants of our gross margin.

We should consider three additional metrics on our dashboard that deal with operations.  First, an indicator of our current utilization of our total available capacity.  Second, customer satisfaction and retention metrics are a valuable barometer for ongoing sales.  And, third, a measure of product or service quality levels.

FINANCIAL – CASH, PROFIT, & HEALTH
We should know what is happening with all of our major current assets, which usually includes cash, accounts receivable (AR), and inventory.  We should quantify the performance of our AR in terms of total % over 60 days past due as well as the Days Sales Outstanding (DSO).  We should understand if our inventory levels are at efficient levels.

We may want to include some of major current liabilities, like accounts payable and line of credit balances.  This information leads to the tracking of the firm’s current ratio on a weekly basis and other versions of the current ratio that traditionally predict cash flow with some accuracy.

CONCLUSION
If we received a weekly dashboard report with all of the information above (tailored to our industry and business model), how well do we think we could manage our business from a deserted island?  Now, we should imagine having all of that information every week along with being in our business every day.  Not only will we feel empowered to make the right decisions to improve cash, profits, and financial health, but we will see our level of anxiety (which comes from a lack of this information) drop significantly.  Even if the dashboard reports bad news, knowing about it will still reduce our anxiety because we will at least have the opportunity to do something about it before it becomes worse.