Many chief executives want to make their businesses more profitable, but they may not understand how to get started. Their first challenge typically is measuring accurately what they do now. After all, before there can be any improvement, there must be a good baseline of measurements in the business—measurements that can have a real impact on the business.
Most businesses we see have a profit and loss statement of some sort. This basic financial report tells owners whether they are making or losing money for the tax man, but it doesn’t tell them if they are making or losing money for themselves.
Among the financial statements that the business’s accountant prepares are the balance sheet and cash flow statement. This is usually the starting point for identifying a company’s key metrics or measurement systems.
But profit and loss statements are just the starting point. To truly understand your business you must first find the numbers that drive your business. Once you figure out what the drivers are, it’s time to start measuring them. We call these drivers key metrics. Understanding those key metrics can often mean the difference between mediocre and outstanding corporate performance.
Key Metrics: A Definition
A key metric is a numeric measurement that can track the profitability of your business. It might be something from your profit and loss statement, balance sheet or cash flow statement. More often than not, it will be a number that you gather outside your normal accounting functions.
For example, most businesses don’t know which customers make money for the business and which customers lose money. Ranking customers from most profitable to least profitable is always a useful activity. And, this activity is often more difficult than it looks.
It’s easy to find out which account produces the most sales. The problem with this approach is that the accounts producing the most in sales are not always the ones that produce the most profit. In fact, many times, the accounts that produce the most in sales can actually cost your company money.
You might ask yourself: If it’s not our regular statements, what should we measure?
The first step in putting together a key metric program is deciding which measurement will have the largest impact for the least amount of effort in your business. This is the low-hanging fruit.
Continuing with the example of evaluating client or customer profitability, you should first figure out which customers made the most money for your company. You would first build a demographic profile of that customer, then find the attributes that all the best customers have in common.
Once you have a profile of your best customers’ common attributes, you can build a marketing program that attracts more of these clients. You also now have a profile of the customers who cost the company money and can figure ways to make sure that the sales department stops selling to this type of consumer or business. With the proper information, we can communicate the appropriate information to the right people in our organization.
They can now start to make plans to improve the focus on our key measurements.
Measurements All Companies Should Look For
The following metrics are the most-often useful when it comes to improving company performance:
- Return on assets of the company
- Return on equity for the owners of the company
- Gross profit
- Profitability per customer
- Profitability per product line
- Net- free cash flow
The metrics that you choose will depend on your business’s largest opportunity. Installing a key metric program is often an early step that companies take when they are changing the focus of their company from tactical to strategic activities.
Often the company will start a measurement program that shows how well the company is doing. A logical next step is to combine a key metric measurement program with a bonus compensation system that ties key metric improvements to individual and group compensation. Measuring, sharing and compensation that is based on key metrics will improve your company performance.
Having a total key metric program in a company is a strategic activity. It moves the entire company to focus on what’s important. Tactical excellence is a given in excellent companies. Strategic excellence is what moves a company from good to extraordinary.
Getting to a different outcome starts with identifying and taking action on your company’s best key metrics.
Josh Patrick, founding principal of Stage 2 Planning Partners in South Burlington, Vt., specializes in working with closely held businesses.
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