As a parent of a toddler, I find myself reminding my son to watch where he is going. His eyes are pointed in every direction that isn’t forward — you know, the direction he’s running at full speed.
My wife and I have probably apologized to you in Meijer after he darted out from an aisle into your cart. Yup, we’re those parents.
But he’s three. We wouldn’t expect a mature adult to run full speed without regard of his surroundings, yet when it comes to our company’s financial position that’s often how we operate. Without a systematic approach to review our key performance indicators, we can’t see when our company has started to wander and needs to get back on track. Sometimes when we start looking, we find we’re going in the wrong direction entirely.
Key Performance Indicators (KPIs) are metrics that can be used to track the success of a goal. KPIs aren’t always hard dollar figures; they can be ratios, or some other quantitative measurement (miles driven for trucking companies, new patients for dentists). Once we know what our goals are, we can start to identify what drives those goals and what drives our success.
Not every company will have the same goals, and not every company will have the same KPIs. For example, a trucking company may wish to track the average cost of diesel, while a dentist may track new “likes” on his or her Facebook page. But perhaps this is all brand new and you’re looking for a place to start.
Good news, I have a few ideas for you!
First, however, I’d like to issue a warning: to get good information you need to start with good data. If we agree metrics are important for decisions, we need to trust the foundation of the metrics. A good bookkeeper is a great first step to good data.
A quick Google search should be able to tell you how to calculate the following ratios, so forego the math and let’s get right to the good stuff — accounting talk.
If inventory is a significant portion of your balance sheet, I’d suggest tracking your current ratio and quick ratio. We’d expect them to move together, but if the current ratio is increasing, while the quick ratio is staying flat or decreasing, that’s an indicator you are holding more inventory. Additionally, you could chart your inventory turns. If it’s trending down, your inventory is growing faster than it can be sold. Sometimes we are intentionally building up a reserve — we do need things to sell — but I’d prefer to keep my extra cash in the bank, not on a shelf in a warehouse.
Another pair of useful metrics is sales and gross margin. We assume gross margin will remain flat as sales increase or decrease. If the gross margin begins to fall, we should look at our direct expenses (cost of labor, material costs) for any changes. Are we paying more for our materials? Was there significant overtime last period? If our gross margin starts to rise we again should look for the reason. If we’re doing something good, let’s figure out what and keep doing it!
There are several more metrics I’d suggest tracking monthly: receivables days outstanding, payable days outstanding and debt to equity. After a few quarters you’ll have a good baseline for “normal operating” and a much better chance of stopping yourself from running wild.