If you don't have metrics, you might well be headed to disaster!
October 20, 2014
Imagine Boeing launched its newest, most advanced airplane, the 000. It is so advanced there are no instruments. All it has is the yoke to fly the plane; everything else is controlled by the supercomputer. So the pilot simply pushes or pulls the yoke to ascend or descend, or rotates it left or right to turn. That's it! Would you want to be a passenger in this plane? A plane where the pilot doesn't really know where he's headed? Or if there was enough fuel? Or if it has too little speed? Or too much? I'll bet my bottom dollar that you will stay clear from this plane!
So if you won't go into a plane that has no instruments, why would you go into a business that doesn't have any indicators? The truth of the matter is that many businesses, smaller and largers ones alike, either don't have any business metrics or have the wrong ones. Metrics are like the instruments on your dashboard, they tell you what is happening. And they mean something. If you are not paying attention to key metrics, you might find yourself adrift in the ocean of failed businesses. If you want to succeed in your business, if you want to ensure business growth, make sure you have the right metrics.
There is actually no universal "right" metric to use. The metrics you choose depend on your business model. However, there are a few important metrics that all businesses need to keep an eye on. These are broken down into financial, customer and performance. In this article, we talk about the financial metrics first. In the following two, we will talk about customer and performance.
This is the total sales that your business generated over the standard period. This is important because the first order of any business is to generate revenue; so if we don't see any revenue growth, we need to put in our pivots (more on pivots in the next article).
EBITDA (earnings before interest, tax, depreciation and amortisations).
This is basically your operating profit before deducting depreciation and amortisation. Essentially, it is
(revenue - cost of goods sold - operating expenses)
This is important because if your revenue cannot sustain your expenses, you are digging a deeper and deeper hole. It will then become beholden on you to either seek increased revenue or decrease your costs.
Your gross margin is the percentage of gross profit over your revenue. Essentially, it is
[(revenue - cost of goods sold) / revenue] x 100%
Your gross margin figures tell you what percentage of revenue is translated into gross profit. If the number is low, it means that your cost of goods sold is high. This may be a reflection of the economy, your market sector, or the quality of your inputs. Sometimes, there is no way to improve gross margin, and when that happens, you need to improve your situation by increasing volume. Other times, you might need to seek out new suppliers or work out a volume discount so that you improve your gross margin.
This is not intuitive. While a company can be profitable, because of sales cycle, collections, credit terms, seasonality, you might not have the cash required to make payments. There is no standard measurement for cashflow. Financial cashflow statements may not be helpful as they take a cumulative picture. Instead, you need to look at your bank account and ascertain how many months' of expenditure you can hold out. Next, look at your accounts receivables and see how much is expected to come in and over what periods of time. Don't forget to factor in your credit terms. This will be a rolling number and if you can keep your cash levels at a healthy level, say, for example, 6 months' buffer, then you are in good shape. Six months may be sufficient for some businesses, but for others who only work on one project a year, then they might need an 18-month buffer.
This is not meant to be a crash course in finance. But all startups need to get a tight rein on their finances in the beginning otherwise things will quickly go out of control.
The next two articles will talk about customer and performance metrics...