How Do You Know If Things Are Going Well?
We ask business executives and owners this question early on: how do you know if things are going well?
It is a simple question, and the answers typically come quickly. Sales are up. Our cash availability is good. We are making decent money.
Lagging Indicators: While those answers are certainly relevant indicators, Sales, Availability, and Profit are all lagging indicators (i.e., “history”).
The question is meant to open a conversation about what additional measures could add value.
The numbers you already trust
Most owners watch a short list of signals closely, and for good reason. Revenue tells you your customers wanted what you produce. A solid cash balance provides comfort so that the business can meet its more immediate obligations. These are valid measures.
Leading Indicators: We promote a broader set of metrics to look at the business as a whole and to provide glimpses of the future. For example, revenue can climb while the mix shifts toward lower margin products. Should your company measure average contribution margin? Cash can look healthy in a month when a large customer pays early, then tighten the next month for reasons nobody saw coming. Should you add a measure for Accounts Receivable?
It is important not to try to measure performance of a complex business with a few broad numbers.
Where "feels good" and "optimized" drift apart
Here is where the conversation usually gets interesting. When an owner tells us what's working, we listen for gaps between what current metrics demonstrate and where new leading indicators (metrics) could allow for greater insights into both future expected performance and where the business can perform better.
The gaps in performance we identify rarely come from a lack of effort. In the companies we work with, the finance team is typically capable and busy. The gap tends to come from what the team has never had time, experience, or support to build.
From our work with small and mid-sized firms, the gaps we see most often include:
The lack of both forward-looking leading indicators
The lack of a 30-60-90-day financial forecast.
No clear set of metrics or KPIs tied to:
The key drivers of how the business makes money.
How customers feel about the business.
Inadequate understanding of product cost and lagging costing methodologies.
Margin analysis that never reaches meaningful, detailed levels such as product families, sales channels, individual products, or customers.
No crisis often means no issue. Sales come in. Bills get paid. That is exactly why "optimized" is easy to miss. A company can run well for years on instinct and broad numbers while a meaningful amount of unrecognized profit improvements and growth opportunities are missed.
Where optimized resides
The upside usually lives one or more levels below the numbers owners already watch.
Margin by product family, sales channel, product and by customer is the clearest example. Total gross margin can look steady while some product lines carry the business and others quietly underperform. Some of your largest accounts may be among your least profitable accounts once full costs are assigned to them. We wrote about this in more depth in What a Fractional CFO Actually Does for a $20-50MM Manufacturer.
We also looked at what this means for your toughest accounts in Your Worst Customers Are Likely Your Best Profit Opportunities.
Forecasting is the other piece. A forward-looking, detailed view of cash and margin turns the numbers from a report card into a planning tool. Instead of learning what happened last quarter, you can see what is likely to happen next quarter and decide what to do about it while there's still time to act.
The right KPIs tie the two together. A handful of measures that reflect how your business earns money, reviewed on a regular rhythm, will tell you more than a standard monthly financial report. The goal is to focus on the few key metrics that matter most. For one company that might mean margins by multiple attributes alongside on-time delivery and margins in the backlog. For another it might mean customer profitability alongside a rolling cash view and some measure(s) of customer satisfaction. The specific measures depend on the business. What matters is that each one connects to a decision someone in the building makes.
This is also where the executive’s and owner's instincts become an asset rather than a blind spot. The people who built the company usually have a keen sense of which customers are worth the trouble and which products are worth the effort. Good numbers either confirm that sense or sharpen it. Both outcomes are valuable, and the second one is often where the biggest gains come from.
None of this requires rebuilding the finance function or company dashboard from scratch. Most of the information already exists inside your systems. It simply has not been organized to answer the questions that matter most.
A quick check on your own numbers
Here are a few questions worth asking about your reporting this week. There are no wrong answers. The point is to notice which questions are easy to answer, and which take some digging.
How will you profitably grow your business over the next 3 to 5 years?
Which of your sales channels and product families earns the highest margin after all costs are assigned, and which earns the lowest?
Which customers would you keep at any price, and which ones could you raise prices for tomorrow without being concerned if you lose them?
How far ahead can you see your cash position with confidence?
When your standard costs and your actual costs disagree, how large is the difference, and does anyone know why?
Which five to eight metrics would tell you the business is on track, and does a report show them to you every month?
Owners who can answer these questions are already in a strong position. For those that cannot, the harder questions point straight at where the next round of profit is likely to come from.
What changes when the numbers line up
When reporting catches up with the business, decisions get easier. Pricing conversations come with evidence behind them, and conversations with lenders and boards get shorter because the answers are already on the page. The owner's instincts do not get replaced. They get better information to work with.
One West Michigan manufacturer we worked with is a good example of how quickly this can move. The CEO was concerned about the integrity of the company's financial reporting and the accuracy of its standard cost. After the engagement, variances fell from about 33% to about 1% of standard costs. You can read the full story in our case study.
Another manufacturer we worked with had two successive years of losses of about 10% of revenue. Upon analyzing their margins by customer, we found there were several customers where prices had not been changed in over a decade, while cost inflation was substantial – and not recovered for years. Upon making corrections and providing detailed PowerPoint explanations to its customers the company retained its customers and became profitable in less than 6 months.
Built to amplify what is already working
We do not come in to tell owners what they have been doing wrong. The business is already working, and our job is to help it work slightly better. We bring the analysis and the experience to provide leaders with good instincts with clear numbers, so the next decision is based on additional facts.
So, we will ask again: how do you know if things are going well? We would like to hear your answer and help you find what the numbers have to say beneath it.
Want a clearer picture of where your profit is coming from? Give us a call.
