So how is your business doing? How do you know? How do you assess how well (or how poorly) your company is performing? How would you know if your are heading for a financial cliff? These are important questions. With the amount of date available to most businesses, it can be challenging to determine what to use to assess the success of the business. This article suggests an approach that can be helpful when designing performance measures that will be effective as measures of success.
In this era of technology, data abounds. So, how does one turn vast amounts of data in to information useful for managing your company? I suggest that you need to consider three things. First, who’s going to use the measure? Second, what aspect of the business do you desire to assess? Finally, what are the best things to compare to get a meaningful answer? Let’s dig a little deeper for each of these.
First, who’s going to use the measure? There are typically three groups of potential users for performance data – managers, owners and lenders. While managers and owners may be the same, their information needs will vary depending on which hat they are wearing. Managers are interested in the operational aspects of the business. Are the assets of the company being used effectively and efficiently. Not just material but is labor effectively deployed and is overhead appropriately applied. Owners perspective is that of long term profitability and return on the investment they have made into their company. It’s not what you make (gross revenues), it’s what you keep (net profit) . Lenders seek assurance regarding the reliability of interest and principal payments on money that has been lent and confidence in the protection against their risk.
Second, what aspect of the business do you desire to measure? Some of the areas commonly assessed include operations, profitability, liquidity, management of resources, financial leverage, market assessment and debt service. There are a large number of measures that are widely accepted for each of these areas. For example operations measures include gross margin analysis, profit margin analysis and expense analysis to name three.
Finally, given all the data out there, what data should be compared to what? It can be tempting to “crunch” all the numbers, creating a vast list of ratios. I propose that a limited number (5 or 6) ratios be selected for each user. The ratios will likely be different for each user as you want measures that are the most useful to each one. Management may select operational measures such as gross margin as a percent of sales or large expense items as a percent of sales. Lenders may be interested in the company’s ability to pay the debts as they come due. A widely accepted measure to do this is the current ratio – current assets divided by current liabilities. If the ratio is greater than 1, it is an indication that the company has the ability to meet it’s objections as they come due.
This article suggests a process for creating meaningful measures for assessing your business. Future articles will examine various widely accepted performance indicators.