Between juggling staffing, operations and cashflow and finding the time to tackle everyday sales and marketing tasks – not to mention the never-ending challenge of keeping customers happy, engaged and loyal – a business owner has a lot to think about.
It’s no surprise then, that the finance side of things often gets left til last. And when a business owner does finally get a chance to crunch some numbers, more often than not it can be a confusing and complex process.
Online accounting platforms like Xero have made the task of collecting accurate and timely financial data very easy. Yet financial data is often meaningless unless you know what to look for, and understand the implications for your business.
One of the most important things you can do as a business owner is to identify your key performance indicators, or KPIs. While KPIs have become somewhat of a cliché (being sometimes confused for meaningless ‘management-speak’), they’re really just a shortcut to determining whether your business is on track for achieving its profit targets.
KPIs measure the key drivers that have the biggest potential impact on business performance. So rather than getting lost in an endless amount of financial data, you can use KPIs to laser in on the right information and quickly be able to identify if you’re on track. If yes, then well done! If not, then it’s time to dig deeper, discover the reasons why and adjust accordingly.
Gross profit: an example
One common KPI for businesses is gross profit. Gross profit is the total sales minus direct costs (i.e the cost of providing your goods or services).
Here’s an example:
A builder with annual sales of $1.6m wants to know what KPIs to keep track of in order to reach his target of generating $400,000 in net profit this year.
Step one: would be to look at fixed costs, such as overheads.These include anything from rent on the office building to insurance, vehicles etc. They’re called fixed costs because the price is generally locked in, with little or no flexibility to adjust. In this example, the builder has overheads of approximately $320,000 per year.
Step two: is to work backwards to determine the appropriate gross profit target.
Starting with $1.6m in sales and subtracting $400,000 in profit and $320,000 in overheads, leaves $880,000 in gross profit.
The builder now knows that he needs to achieve $880,000 (55%) in gross profit to reach his target of $400,000 in net profit.
But if the end of financial year is still many months away, how does he find out if he’s on track to hit a gross profit of 55%?
By breaking it down and measuring the gross profit on every job or project that the business completes.
If every project has a gross profit of 55% or above, then the business is on track to hit its profit targets.
Now the builder has identified one of his key KPIs – the gross profit of each project.
If gross profit dips below 55%, he needs to investigate further and find out why. Did he spend too many hours on the job or waste too many materials? Or did he under quote on the job?
This shows how valuable KPIs can be, shining a light on potential areas of improvement and offering a valuable shortcut to help demonstrate where an owner should spend their time.
Leading indicator KPIs
When selecting the right KPIs, it’s important to ensure that some of them are leading indicators.
What does this mean?
A leading indicator is something that flags a potential future problem.
For example, if you’re targeting sales of $1.6m per year, it may seem obvious to break that down into a monthly KPI of $133k in sales per month. Yet by the time you realise that sales targets have been missed this month, it’s too late to do anything. A leading indicator would perhaps ask,“how many quotes did we do this week”. If you know that on average, 50% of your quotes get accepted, then you’d understand that $266k of quotes should be sent out each month (i.e $61k per week). Then if you don’t hit your quote KPI in a particular week, it gives you time to try and correct the course before the end of month.
Similarly, measuring the number of lost clients per month is called a lagging indicator – but measuring customer satisfaction each month is a leading indicator, and gives you a better chance to prevent client losses before they happen.
How do I know which KPIs focus on?
Every business is different – so it’s important to take the time to study the best potential key drivers for your business. Your KPIs could be a mix of profit ratios, cashflow, sales indicators, customer satisfaction or debt levels. The list is extensive, but the most important thing is to start a process of setting the most relevant goals and then determine which KPIs will best get you there.
Ready to determine your KPIs? Talk to Liston Newton Advisory about your business.
1. We start with a goal-setting meeting to determine what you want to achieve, your business goals and how much you want to pay yourself
2. We work backwards from the profit target to determine what your P + L statement needs to look like to generate the profit you want
3. We help you determine the best KPIs to drive the results you want
4. We set a 90-day, 1-year and 3-year plan to make this happen
5. We check in every 90 days to help you stay accountable.
Result: your profit is now planned, and no longer left to chance.
Contact Liston Newton Advisory for an appointment to discuss how we can help you establish the right KPIs, for maximum profitability and ongoing success.