AUTHOR: Leigh Risbey
This article is for guidance only and is not a one-size-fits-all for business.
We will cover the basics of:
- Profit and Loss (P&L)
- Key Performance Indicators (KPI’s)
Profit and Loss (P&L)
There are a few things that every business needs to measure to track financial performance; they will come as no surprise:
- Costs to sell
- Fixed Costs
- Variable Costs
These categories can be more involved but, to allow yourself to focus on more important tasks, don’t allow your accountant or other well-meaning advisor to drag you into the minute detail of cost categories. Simply understand the key numbers and how to judge whether they are good, indifferent, or bad!
Let’s look at each of them in turn:
Income is any form of MONIES RECEIVED FOR GOODS OR SERVICES SOLD. If you receive funds from a grant or subsidy, donation or gift, this should be itemised separately and understood. If these are regular sources of funding and you need to produce work or goods to qualify for them, they may be considered ‘Income’. Let’s not get bogged down with that; just be aware that if it is not regular income based on your core activity, be careful about relying on it to sustain the business. For example, recent Government COVID-19 subsidies are not core income and they will stop, if this has not happened already. They should NOT BE CONSIDERED AS INCOME for the purpose of knowing if your business is making a profit. They did, however, provide useful cash flow which was the intention.
Income for goods or services is sometimes called the Top Line. This represents product lines, services or a combination of these, and is best itemised by the respective goods/service categories. Ultimately, you need to know what lines are going well and which are not. For the purposes of a business Health Check, we only need to know the OVERALL TOTAL INCOME from sales of Goods and Services.
- Cost to sell:
This is usually referred to as Cost of Goods Sold (COGS). It includes all costs associated with actually selling the product or service, not embedded business costs associated with providing the product or service. Inventory/materials purchase costs, marketing, freight and sales-related costs would all form part of the COGS. In some industries where businesses on-sell sub-contract labour, this expense may also be included in the COGS.
It is important to know what is included here and how it fluctuates with Income because this directly affects profit.
- Fixed Costs:
A fixed costs is any expense that remains constant regardless of changes in activity related to sales and income. These could include salaries for management or administrative staff, or buildings costs including rent, rates, utilities and insurances. Loan repayments and interest charges can also be allocated in fixed costs as well as regular memberships or licensing arrangements.
- Variable Costs:
These costs are not directly associated with COGS but may vary when sales change. For example, the labour component of producing goods may not change with an increase in volume of goods sold if this increase is distributed across several categories of goods, or if efficiencies are achieved to increase production. However, a sustained change in the volume of goods produced may result in a change in labour costs.
Another example is fuel use in vehicles that deliver goods or services to customer premises. If demand is seasonal, fuel use will vary in months of higher or lower demand. Likewise, the repairs and maintenance costs may vary according to vehicle usage, but registration and insurance are likely to be fixed costs.
The all-important ‘What is Left Over?’!
Simply taking away all the costs from the sales leave us with the profit.
Sales Income – COGS – Fixed Cost – Variable Costs = Profit
If all we monitor on a regular basis is:
- Sales Income
- Costs (total) and
then we will have some idea of where things are headed.
So, what is a ‘regular basis’?
This will depend on the business, the sales cycle and the expense cycle, but most businesses should review monthly at a minimum.
You will have heard the term: ‘Cash is King’. If that is the case, then Cashflow is the ‘Queen’. What’s the difference? Cash is static, a value at a moment in time, whereas Cashflow is dynamic. Cashflow is cash in action and therefore has life-sustaining properties which are essential to every business.
Monitoring Cashflow is perhaps the most important business metric as a business will cease to exist very quickly without cash flowing.
Cashflow monitoring is often seen as a chore and all too often ignored until the bank calls to ask a few uncomfortable questions.
Don’t let this happen to you – it is difficult to recover when the cash runs low and eats into your working capital. There are many simple methods and tools to use to keep an eye on your cashflow.
Take some time to set up a simple spreadsheet that is easy to maintain. Keeping it up to date can then be delegated. A daily, weekly or monthly check of just three numbers will let you know where you are at:
- Cash In
- Cash Out
- Net Cash Position
Provided the Net Cash Position remains at or above the level we are comfortable with, then we can get on with our day.
What is a comfortable level?
This depends on several factors and professional opinions vary.
A COMFORTABLE position may be considered as the amount of cash required to service all costs and debts for the next period required to receive more cash into the business – this is the cash cycle.
A BETTER position would support the business for a period beyond the normal operating cash cycle.
A SUSTAINABLE position would be where this period is extended to a few months.
A HIGHLY SUSTAINABLE position is where the business can self-survive for 6 months or more.
These descriptions are highly subjective and you could reach a more objective assessment through a deeper analysis of the business. This would include all assets, types of assets, cash reserves, business structure, ability to raise funds, etc.
Knowing your cash position at any given time, and what this means, gives you useful information on which to base good decisions.
Key Performance Indicators (KPI’s)
Key Performance Indicators are often frequently mistaken for simple operating measures or metrics.
A KPI measures an activity or an outcome of activities that is CRITICAL TO THE PERFORMANCE OF THE BUSINESS in achieving the defined goals.
For example, a KPI may be the overall time taken to assemble a finished good ready for sale, measured in minutes or hours per unit of finished good. Another might be the sales growth over a specified time period.
A KPI IS NOT a business metric such as headcount or number of cars in the fleet. These do not individually measure success towards a goal or objective.
Essentially, good KPIs provide objective evidence of progress towards achieving a set goal. This evidence can inform decision-making so that decisions can be made confidently with full knowledge of their impact.
Measured over time against a target, KPI’s track short-term fluctuations and longer-term changes in performance.
KPI’s can include and help track efficiency, effectiveness, quality, timeliness, governance, compliance, behaviours, economics, project performance, personnel performance and resource utilisation.
All businesses benefit from good KPIs and a clear set of strategic goals. A complex business does not need complex metrics and measures. Well designed and easily understood KPI’s can simplify the management of any business and provide meaningful insight and early indication of inconsistencies. KPIs can provide a healthy balance between lead and lag indicators, allowing for adjustments before surprises occur.
What are the Key Metrics for your business?