What’s Really Going On At Your Company?
Is David Bush having a good season on the mound for the Milwaukee Brewers? A typical baseball fan might point to Bush’s record (five wins and nine losses at the time of this writing) and 4.69 earned run average and conclude it’s been mediocre at best.
Look at the numbers a little deeper, though, and a different story emerges. While Bush is short on wins, his 1.16 “WHIP”–that is, walks and hits per inning pitched–is one of the best in the National League. You may not know that stat, but you can bet Bush’s bosses do.
Like savvy coaches, savvy entrepreneurs mind their stores using a flurry of metrics. Some are obvious–things like revenues, gross profit margin and dollars of scrap–but many others aren’t (or at least they’re not monitored). And while you don’t have to be a Wall Street securities analyst to run a successful small business, having a handle on these numbers can make a huge difference–both in day-to-day management and in long-term planning.
Cash Flow From Operations.
Net income is nice, but cash flow is truly sweet. While the first is an abstract accounting measure, the second reflects the hard reality of how much cold currency is flowing into and out of a company.
The cash flow statement is a marriage of two other financial statements: the income statement (which tallies revenues and expenses) and the balance sheet (which records “working capital” accounts, such as receivables and payables). Example: Say your business has revenues of $1,000 for a given month, but all the merchandise was sold on credit (meaning that you didn’t actually receive the cash in that period). Now say total cash outlays were $750 for the period. In this case, your income statement would report a “profit” of $250 ($1,000 in total revenues less $750 in expenses). Meanwhile, however, cash flow dropped by $750. That’s because the business had to pay $750 in cash expenses but did not collect any offsetting cash from customers. An increase of $1,000 to accounts receivable balances the books.
The specific metric to watch: cash flow from operations (as opposed to cash from financings or investment income). Operating cash flow represents how much cash the company generates from its core operations–essentially, how well its heart is pumping. The calculation: net income plus depreciation and amortization (both non-cash charges), minus capital expenditures (new equipment and such), minus changes in working capital. One other important thing about cash flow: It is the metric generally used by investment bankers to determine the value of your company.
The longer stuff sits on a company’s shelves, the lower the rate of return on those assets and the greater their vulnerability to falling prices. That’s why you want to keep your inventory moving, or “turning.” To calculate inventory turns, divide revenues by the average inventory level (in dollars) over the given accounting period. The greater the ratio (or number of turns), the greater the return on your capital. (An alternative method: Change the numerator to “cost of goods sold” and divide by inventory; this maneuver accounts for the fact that inventories are carried on your balance sheet at the original purchase price, while revenues are recorded at current market value.)
Receivables Growth Vs. Sales Growth.
Relax–it’s OK if receivables pile up a bit, as long as they grow proportionally with sales. If receivables begin to outstrip revenues, then you aren’t getting paid–meaning that you might be short on cash when you need it most. For more on this topic, check out How To Collect From Deadbeats and How Much Credit Do Customers Deserve?.
Nothing stings worse than losing the trust and respect of your customers–and that’s exactly what happens when you blow a delivery date. Missed dates should be flagged and investigated. The snafus may be flukes; then again, you may uncover a nagging flaw in the system. Like any other metric, track delivery trends over time.
Sales may be brisk this week, but how will they look 90 days from now? Tracking this forward-looking metric–defined as committed orders plus forecast sales, weighted by the probability of landing those deals–ensures that you’re not running right off a cliff.
Interest Rate Coverage.
No matter the credit environment, the answer to whether your company can consistently generate enough income to cover interest on borrowed money is a need-to-know item for lenders. There are many ways to define an interest-coverage ratio, but a common one is earnings before interest and taxes (or EBIT), divided by interest expense. Banks take this metric very seriously–so should you. For more on balance-sheet management, check out An Entrepreneur’s Most Important Asset.
Every industry (and company within it) has its own set of meaningful metrics. Choose ones that capture performance from all three perspectives–in terms of income, leverage and cash flow–and track them week-in and week-out. Remember that each number tells a different story, and only taken together do they deliver what all smart owners ultimately crave: honesty.
Gene Marks is owner of Marks Group, a technology consulting firm, and author of The Streetwise Small Business Book of Lists.