Business is easy - right? You buy something, you sell something, you pay some overheads and you make a profit? Individual transactions certainly are easy, but as businesses grow and employ people it becomes impossible to control every transaction. You begin to aggregate these transactions into totals for a period of time in the form of a profit and loss account. Business owners monitor these totals, feedback to their team and strive to achieve the desired results.
However, understanding the key drivers behind business results is more important than the profit and loss account itself. Every industry has standard Key Performance Indicators (KPIs), which need to be considered in tandem with financial results. The most effective business owners will ensure that some of these KPIs are "lead measures" which provide insight for results in future months - the pipeline of future profits.
In every business, the equation for sales is: sales volume x average price = turnover. For example, a hotel’s average price is called the Average Room Rate (the average value each room has been sold for). Increasing the Average Room Rate will increase turnover. However, you also need to keep track of the sales volume because this will fall if your Average Room Rate is too high. Here, the volume can be tracked simply by monitoring the number of room nights booked, but many businesses focus on the utilisation of their assets instead (see below) - aiming to maximise the sales volume by reference to their available capacity.
This is a "lead measure" - it provides insight into your future sales. By keeping track of the value of potential sales opportunities together with the conversion rate it provides some comfort for future sales. There are two levers to monitor: the volume of sales opportunities and the effectiveness of your sales process through the conversion rate. High volume is no good without a respectable conversion rate. Similarly, a high conversion rate with an insufficient flow of opportunities won't result in your targeted growth.
This is essential for businesses that rely on repeat custom or word of mouth to generate sales enquiries. A "Net Promoter Score" indicates whether a customer is likely to promote your business to friends and family. It's used worldwide and only requires customers to answer a handful of questions post-sale. Coupled with this measure, most businesses that deliver recurring services will also track the value of customers lost in the period.
For most businesses, their people are essential to the delivery of their services and they recognise the importance of keeping them happy. Many factors dictate how engaged your employees feel, it's not just about their salary. By conducting regular surveys with your team they feel listened to and engagement plus performance will increase. Preventing the cost of recruitment and retraining means this measure is vital for people-based businesses. Some businesses also track employee absenteeism. Armstrong Watson conducts its own employee engagement surveys through PDW. Find out more here.
This is a measure of the output from your workforce or the utilisation of your assets. It is expressed as a percentage being the output divided by the capacity. For manufacturing, this would be the volume produced by a person or team expressed as a percentage of the capacity available during the period. For a hotel, it’s the volume of rooms booked divided by the total number of rooms available. For professional services, this is the chargeable time divided by the total time available from the workforce. Ultimately, the utilisation of your employees or assets and the busier they are, the more profit will be made (subject to your average price being correct).
If you're building products or selling services, the quality of your output is essential to reduce wastage. For manufacturers, this would be expressed as a percentage of good products divided by total products produced. If 2% of the products were rejected by quality control/customers, the yield is 98%. For legal services, this would be billed time divided by chargeable time and is commonly described as the recovery rate. You can also multiply this percentage by the utilisation percentage to calculate an efficiency percentage. Although improving this percentage requires issues within the utilisation and/or yield percentages to improve profits.
Most businesses will track their profitability at a gross profit or net profit level, which can be expressed as a percentage of sales. These percentages are normally visible on the face of the profit and loss account. The value in this percentage comes from your profitability by department/product line/service type. By monitoring these KPIs you can address problems with efficiency, negotiate purchase prices and focus your sales teams on your most profitable products or services.
Profits are great, but cash is king. The working capital cycle is important, particularly for growing businesses where cash can be exhausted easily. Businesses will have payment terms for their suppliers, payment terms for customers and a period when cash is tied up in stock or work in progress. These are often expressed in days - 45 Debtor Days would mean it takes your average customer 45 days to pay your invoice once you've sent it. Managing these days will directly control the cash in the business bank account.
For all the above you need a reference point. For some of these KPIs you won't be able to back-track to provide a comparable figure and monitor improvement. It's also important to build your financial budgets using your KPIs so that you can compare the business performance with a comparable period and your budgeted expectations.
Once you've identified the right KPIs for your business, it is important to monitor these regularly. Many business owners use a live dashboard for their KPIs which is real-time, this allows them to take immediate action rather than identifying these at the end of the month within their profit and loss accounts.
This is not an exhaustive list of every KPI a business could use, but hopefully provides a flavour of the measures that can be implemented in your business.
Our Outsourced Accountancy Services can provide the right financial information and KPIs to allow you to focus on your business, get in touch for more information.