What will your cash flow situation look like next week, next month or in a year? Find out why it’s important to know, and how to calculate it.
Identifying and monitoring the key drivers of your business is critical to boosting profitability. A key business driver is something that has a major impact on the performance of your specific business.
A whole range of internal and external factors affects the performance of every small business. The secret is to focus on a handful of key drivers that:
- reflect the performance and progress of your business
- are measurable
- can be compared to a standard, such as a budget or last year's figures, or an industry average
- can be acted upon
Sales or revenue is one indicator that it easy to monitor. Most businesses measure this at least monthly but many measure it daily or even hourly. But sales might not be the actual driver for your business. It could instead be the number of sales calls you make, or your follow-up service campaign, or the amount of traffic that hits your website. These are the drivers that help you generate sales.
Use your historical figures as a benchmark for your current performance. Figures for last year and last month provide hard facts and established patterns for your business, and identify potential problems and opportunities. In addition to your internal benchmarking, try to compare your business with other similar businesses, especially competitors. Your accountant, or industry body may be able to supply comparative figures for your industry or help you access the data.
Some key drivers
The range of business drivers varies enormously from business to business. For example:
- sales leads in a capital goods or service business
- sales per square metre in a retail business
- machine downtime in a factory
- 'first time fix' in a maintenance business
Even direct competitors may use different drivers to improve their business performance. For example, prime location is not a key driver for an internet-based business selling computer parts, but it is for a 'bricks and mortar' competitor that relies on well-located retail stores to attract foot traffic. Following are some drivers that could be relevant to your business.
Enquiry levels (or number of leads, or quotes given) provide early warning of any peaks or troughs in your sales.
Monitor where the enquiries come from to establish which marketing campaigns work. If you have an established enquiry-to-sales ratio and know the size of an average sale, you can use the enquiry level to forecast turnover.
When you review sales, monitor the figures that show what is happening:
- Which categories of product are selling well?
- How are your priority products (those with the best margins and the best payment terms) selling?
- Are your conversion rates (the ratio of leads to sales) changing?
If you don't know where your queries are coming from, now is the time to find out so you can assess if there are more where they came from.
Like sales, your costs (and therefore profit margins) should ideally be tracked every week. Focus on the key variable costs (the cost of materials or inputs to make products), and what causes them to increase or decrease. If you run a service business such as a consultancy that bills out time, it can be useful to regard consultants' salaries as variable costs (rather than direct or overhead costs) as this can more accurately reveal your true gross profit figure.It isn't hard to work out who is making you money and who isn't.
Maintaining a healthy gross profit margin is critically important. If your margins are falling, then you need to pinpoint why this is happening so you can take corrective action. The cause could be any number of things, such as higher input prices, a changing product mix, production inefficiencies or offering too many discounts.
Your working capital
To make sure you don't run out of working capital (the cash in the bank you need to pay the bills), calculate how much extra working capital you require to fund each extra 10% increase in monthly sales. If you don't have sufficient finance available, meet with your NAB Small Business Banker to discuss possible funding options.
If you have overdue debts it's a sign that all is not well, especially if any of your customers are likely to default and leave you out of pocket. If your debtors' book is large and bad debts could place your whole business in danger of going bust, then it is a key driver to monitor. Pay close attention to your debt collection system and implement necessary improvements immediately.
An effective way to control debtors is to produce an aged list of debtors every week, showing which bills are overdue, and by how many days. Any payments that are overdue, suspect, or simply large should be highlighted and tracked so you can take prompt action. The key is consistency – late payers should know that you will unfailingly contact them.
Your inventory levels
Good stock control allows you to keep relatively low inventory levels while still keeping customers happy. A photographic retailer realised that their suppliers were providing a very reliable one-day turn-around for stock replacement. This meant the business needed to hold only one or two of each camera model, reducing their inventory by $30,000.
Your stock turnover rate is the ratio of cost-of-sales to stock. Most businesses aim for a high stock turnover rate, because it indicates an efficient use of capital resources. If the ratio decreases, find out why. For example, you may be overstocking or purchasing stock that you cannot sell. The more you break down your stock figures into separate product categories, the easier it will be to pinpoint problems.
Hours sold per day
A management consultancy had a disappointing level of monthly sales for years, until the owners realised that hours sold per consultant per week was the key driver. Once this was monitored, it became crystal clear which consultants were earning the revenue. Attitudes changed overnight and sales increased significantly. The consultancy was then able to seek small improvements that were manageable, such as selling 30 minutes more a day each.
After a period of stability and high profits, a specialist travel agency realised that staff turnover was a driver. An experienced sales person was found to be three times more productive than a new recruit. The recruitment and training process for new sales people was also a major burden on the business. To reduce staff turnover, the travel agency introduced a long-term incentive element into remuneration packages. It also introduced quarterly performance reviews.
Your key drivers
What are the key factors that enable your small business to outperform its competitors? Try to identify the key drivers you need to focus on. You need to ask yourself what drives the:
- sales figures
- cash flow
For most businesses the key drivers include major cost-efficiency items. Drivers often include 'soft' factors. For example, effective networking (the ability to build new business relationships) has proved to be the key driver for many small businesses.
The measurement of drivers is sometimes indirect. For example, if you have identified employee morale as a driver, you could monitor it by tracking voluntary overtime, absenteeism and sick days. The drivers may change with time due to the growth of your business, changes in your market or simply seasonal changes.