By: Heidi Pozzo
Many businesses wonder why they aren’t profitable or why their bankers don’t think they aren’t focusing on the right thing. Or they track lots of metrics but wonder why earnings aren’t going up. Or they aren’t tracking anything at all.
Measuring key business drivers is important to getting the results you want because things that get measured get managed. So, choosing the right things to measure is critical. Over my career in advisory roles and internally in business, I’ve seen a wide range of metrics (or lack thereof) and regular or no focus on measuring and managing them. The most successful businesses measure a small group regularly and are keenly focused on value drivers on a daily basis.
In this article, I’ll highlight five metrics that matter in business. There may be a few more that are industry specific and critical to measure. The key is to keep the number fairly small to focus attention on managing the metrics that matter and can have the biggest effect on the bottom line.
EBITDA is Earnings Before Interest, Taxes, Depreciation and Amortization. As an income statement metric, it measures the earnings generated in the business without regard to how the business is structured from a tax or financing perspective. It allows for the most comparable method of comparing earnings across businesses, while focusing on the operations of the business. Many times it is viewed as an indicator of how much the operations of the business are generating.
In an established business, EBITDA should always be positive. The level to which EBITDA is positive will vary by industry. EBITDA funds investment in assets that support the business, taxes and returns to shareholders. Benchmarking to comparable companies will give you a perspective on whether the company’s operations are performing well.
The income statement doesn’t capture the amount of cash coming in or going out of the business. Cash flow includes the amount generated by the operations of the business, as well as investments in assets (buildings, equipment, etc.), debt financing, and changes in working capital (accounts receivable, inventory, etc.). This is a critical metric because it is possible to have positive earnings while having a negative cash flow.
Cash flow is a good basic measure to determine how earnings from operations are being utilized in the business. For example, is working capital (the amount of cash invested in producing and selling products including inventory, receivables, etc. outside of major equipment) being minimized? Is more cash being put in the business in terms of major expenditures than is being generated by operations?
Liquidity is the metric that shows how much cash is available to the business and can include cash on hand and lines of credit. This is particularly important to understand in businesses that are seasonal or cyclical. Meaning that during slower times, additional cash is needed to get by. While cash flow tells you how much cash you have today and where cash has been spent, liquidity tells you how much cash you have available in the future to operate or invest in the business.
To determine if current liquidity is sufficient to meet near term needs, the company would look at the monthly cash flows (or mid-month if there is a spike that a month end would not capture). Those monthly cash flows would take into account the cash generated by operations, as well as capital expenditures, debt service, interest payments, etc. If the month shows negative results and there is not sufficient cash on hand or credit line availability, it is time to either adjust spending or obtain additional sources of liquidity.
Margin by Product or Service
Margin by product or service is the revenue less the direct cost to produce the product or service. Many times some allocation of cost is developed to determine the margin. Getting the allocation right is critical, so that as levers are pulled the bottom line results change as expected.
With known margins, lower margin items will be targeted for price increases, cost decreases or elimination from the portfolio. This perspective may also help drive discussion to new innovations that can continue to generate incremental margin. In managing margin by product or service, the company can proactively address poor performers while increasing strong performers.
Overhead represents how much you are spending to support the operations of the business through sales and administrative functions. Depending upon the industry, there are a number of ways to measure the overhead – as a function of sales, headcount, etc. It is important to balance the level of overhead to the business, with the most efficient use of dollars as possible. This doesn’t mean underinvesting – that can get you in trouble just as much as overinvesting. The idea is to get the biggest bank for your buck when you investment in the people, processes and technology that support operations.
In addition to the five metrics listed above, you may want to consider identifying a metric that tells you how the market is performing in your industry or a key cost metric that signals if your input costs may change. The key is to have a holistic view of your business. Whatever you do, keep it simple, straightforward and manageable. The few metrics you use should tell you how the business is performing and whether you need to make course corrections. What can you do today to enhance focus on managing the metrics in your business?
Copyright © Heidi Pozzo.
Permission is granted to reprint this article in your newsletter or magazine with the following byline and click-able link:
Heidi Pozzo is a strategy and performance improvement consultant. She has helped transform businesses, resulting in significant increases in earnings and business value. To find out more about her services,
or call 360-355-7862.