Articles

How to calculate the key numbers in your business

May 5th, 2011

For any business to succeed there will be a number of key indicators that need to be measured, but they normally fall into 2 distinct areas. One set of indicators will have to do with activity, while the second set will relate to your balance sheet.

Activity Metrics

Activity is all about the ‘doing’ part of your business – the things that need to take place to deliver your goods or service. This might include such information as:

  • Sales metrics
  • Productivity
  • Gross profit
  • Work in progress
  • Expense ratio

Most people seem to be able to understand these figures, even if they don’t always look at them.

Balance Sheet Information

Mention balance sheets and it has a similar effect to mentioning the word budgets – eyes tend to glaze over and the ‘I wish he’d hurry up and finish look’ arrives. But at the end of the day you can do a lot of activity, but if you aren’t profitable or more importantly solvent things can start to look a little ugly. Ratios in this area might include:

  • Liquidly Ratios (current and quick)
  • Debt to equity ratio
  • Interest cover
  • Payable days
  • Receivable days
  • Stock turn
  • Net operating profit
  • Profit per employee
  • (are you still awake?)

Let’s look at some of these in more detail

Sales metrics

This is all about understanding your sales activity. What leads are there in the pipeline, what is the conversion from leads to proposals and proposals to sales. What is the average time to convert a sale, what source do they come from and what is the average value of a sale.

Productivity

This is looking at actual work charged v actual cost to the company. To get accurate productivity you need to take into account what hours are available to be delivered in the first place – don’t forget to take into account annual leave, non productive time such as meetings and admin time

Gross Profit

What is the cost to deliver the goods or service v the income?
Income – cost of sales = GP$
GP$ / sales$ = GP%
Remember it is the GP$ and not the % that pays the bills, so keep an eye on the actual $ amount, not just the %

Work in Progress (WIP)

This is measuring what income activity is actually happening in your business. Some businesses record WIP as actual activity in a period, others record it as confirmed sales in the pipeline. Regardless the purpose of WIP is to allow you to look ahead. For example if your sales target is $2m and you have $400k of WIP, you have about 2.5 months of work ahead of you

Expense Ratio

This is the comparison of expenses v income and allows you quickly to see what expenses are impacting on profitability and also any expense swings. Very helpful when you are benchmarking your activity against industry standards.
Expense$ / sales$ = expense ratio

Current liquidity ratio

This is a test to see how solvent your company is.   Can you meet your obligations
Current assets / current liabilities = current ratio

Acid test quick ratio

Current assets – inventory / current liabilities – bank overdraft = quick ratio

Debt gearing ratio

Keeps an eye on the debt exposure
Total debt / equity = debt to equity

Interest cover

Can the company meet its interest requirements?
EBIT (earnings before interest & tax) / Interest paid = Interest cover

Payable days

How long do you take to pay accounts payable (comparing payable & receivable days helps in understanding cashflow)
Average payables (3 month average) / cost of goods
 x 365 = payable days

Receivable days

How long it takes you to get your hard earned money in. From a cash cycle perspective payables should be longer than receivables)
Accounts receivable / sales
 x 365 = receivable days

Stock Turn

This is how long it takes you to turn or move your stock. The quicker you turn it the less your holding cost will be
Cost of goods / average inventory (3 months rolling) = Stock turn

Net Operating Profit

This allows you quickly to see what net profit (average) you are likely to make from your sales. Very helpful for benchmarking and also quick budget calculations
EBIT / Sales$ = NP%

Profit per employee

Helpful for benchmarking and also analysing current period v previous periods
Net profit$ / number of FTE fulltime equivalent employee) = Profit per employee

Are you still awake?

Well done if you’ve reached this point and are still with me. As you can see you can just about measure anything that you want. The key is to work out what are the 4 or 5 key drivers to your business and then focus on those on a regular basis (activity metrics may be as short as daily and balance sheet should not be any longer than monthly).  Be careful though that you don’t get paralysis by analysis.

It also depends on your role in the business. From an operational basis you want to be on top of those activity metrics all the time, because if you are hitting those you should by default hit your budget.

On the other hand the balance sheet ratios are when you are wearing your director’s hat from a governance perspective. Here you are taking a longer term view of your business.

So think about what numbers are important to the success and profitability of your business and start capturing and measuring

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