“Optimism is a strategy for making a better future. Because unless you believe that the future can be better, you are unlikely to step up and take responsibility for making it so.”
― Noam Chomsky
Entrepreneurs are optimistic by nature. There is an intrinsic belief that their business will succeed. Even when faced with long odds, the best founders take each day at a time, iterate and improve upon failures. While COVID has dulled some of this optimism, the pandemic has also provided an opportunity to reevaluate and improve everything about your business processes. This should absolutely include the Company Scorecard that tracks your Key Performance Indicators (KPIs).
“Measurement is the first step that leads to control and eventually to improvement. If you can’t measure something, you can’t understand it. If you can’t understand it, you can’t control it. If you can’t control it, you can’t improve it.”
– H. James Harrington
Today we build off our previous post, “The New Abnormal”, which was written in “real-time” and focused on navigating through the quickly shifting landscape caused by COVID-19. Whether intentional or not, there is no doubt you have had to make strategic decisions in the last four months that significantly changed your business. But how did it go? How do you know? Where do you go from here?
In this two-part series, we will help you reevaluate your Company Scorecard and how you measure success. Part One will focus on Trailing KPIs and Part Two will focus on Leading Indicators.
First, what changed in your industry and with your customers?
This will vary wildly from industry to industry, but COVID-19 created significant demand for some goods/services and massive decreases in others. We now have data from the last few months to review the basic Trailing KPIs. Based on your experience so far, identify those changes and what you believe to be a permanent change:
- How did your customer’s purchasing decision process or budget change?
- Can you attribute this to a temporary decrease in demand for your product or service or will it never come back?
- If you could pivot your business to a new opportunity could you do it?
- Does your business require changes to the physical office or retail space to continue to operate?
These are all important questions to be asking about the long-term viability of your business and will help you select the right KPIs to start tracking.
Trailing KPIs – The Basics
Now that you’ve taken an anecdotal look at the macro-environment and changes to your business, the next step is to look granularly at the accompanying financial data. The hope is that you are already tracking or have access to your basic financial KPIs, so take a look at the trailing 3, 6, and 12-month figures pre and post-pandemic to identify specific trends in your business.
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- Revenue – The most obvious metric. How did your business model hold during the pandemic? Look at revenue by product/service, did one revenue stream perform better than another? How are your contracts structured to solidify revenue for the future? Are customers lost forever or were there just collections delays?
- Cost of Goods Sold – Depending on your business, how did the pandemic affect your cost of product or service delivery? Is the disruption permanent? Should you start to diversify vendors to combat supply chain disruptions?
- Cash Flows – Check on your changes in cash flow during the period. It’s likely there was a major cash crunch given the circumstances which lead to many decisions that were made (furloughs, PPP loans, delayed payments to vendors/creditors, etc.). Did you have sufficient Lines of Credit to manage? What are the ways you can increase cash flow now that profitability will be paramount moving forward?
- EBITDA – How did the decisions made during the pandemic affect your bottom line? Perhaps there were surprises and you were able to offset topline revenue decreases with efficiency gains.
Refocus Trailing KPIs on Resources and Profitability
Even if your business model is still intact, growth has likely slowed. This is the time to evaluate your organization from a resource perspective. With limited resources, where are your limitations and efficiencies creating bottlenecks? What can you consolidate? Where can you invest in technology automation or outsourcing to drive operational efficiencies and be more capital efficient? Focus on systemization, process workflows, and automation to hold profitability steady (or grow it) even as top-line growth slows.
With a shift in focus to resource management and profitability as you emerge from the pandemic, basic financials tell some part of the story, but you will need to identify metrics that provide more nuance. Here are some suggestions to revamp your trailing KPIs:
- Revenue per employee (Total Revenue / Number of Employees) – As resource management and profitability are prioritized, revenue per employee can quickly identify how efficiently a company utilizes its human capital.
- Profit per employee: (Total Profit / Number of Employees) – In the same vein as revenue per employee, profit per employee is a great measure of ROI on talent. Measuring talent relies on many intangible factors, but profit per employee is a good indicator of how well your team is innovating and executing.
- Gross Profit Margin: (Gross Margin / Revenue) – While a relatively basic profitability metric, truly understanding your gross margins require you to have a proper Chart of Accounts structured to incorporate your Cost of Goods sold.
- Gross Margin Per Sale: (Revenue from a single sale service/COGS of completing that service) – Understanding the unit economics of your business is incredibly valuable to know if your business model is viable or not. Focus on developing a process for “job costing” and developing your margins per sale.
- Accounts Receivable Turnover Rate: (Net Credit Sales) / ((A/R at Beginning of Period + A/R at End of Period)/2) – The A/R Turnover Rate is a good indicator of how efficiently a business collects from customers when there are 30/60/90 day terms. A higher ratio benchmarked against industry peers can identify how many times per year a company turned their A/R over. Increasing this metric can increase cash flow.
- Customer Acquisition Cost: (Cost of Sales + Marketing Activities)/(Number of New Customers) – This is an incredibly important metric. Reducing CAC increases the profitability per customer by shortening the payback period necessary to break even on a new client.
- Rule of 40 (Software businesses) – (Growth Rate + Profit Margin) – If you are a software company, a good metric to track is your Growth Rate plus Profit Margin. Given many software companies are venture-backed, an attractive benchmark for acquirers for these two numbers to add up to 40%. So if a SaaS company is growing at 60% and is -20% for their profit margin, this is still an attractive acquisition target given growth. Similar to a company growing at 20% and a 20% profit margin is as attractive due to how profitable it is. It’s a good balancing measure depending on how quickly you want to scale the business.
- Quick Ratio (“Acid Test”): ([Current Assets] – [Inventories]) / (Current Liabilities) – A very important measure of resources available to meet short-term financial liabilities. This is very important to track to understand the backstop in the worst-case scenario, you know, like a global pandemic.
Take the time to develop your Trailing KPIs to better measure profitability and company performance as you develop a new strategy forward. By better understanding the past, you can benchmark and measure against future decision making. If pulling the information necessary to calculate these metrics is difficult, reach out to Compass East and let us create the proper accounting infrastructure necessary to develop your Company Scorecard.
Stay tuned for Part Two which will focus on choosing the best Leading Indicators for your business.
Questions? Finance and Accounting needs? Schedule a Free Consultation today!
John Lanahan
Director Of Financial Strategy
john.lanahan@compasseast.com