No matter why you went into business, judging its success comes down to one thing: money. Do you have enough to continue and move forward?
To measure how you’re doing financially, you need to establish key performance indicators, which will help you to make informed business decisions such as:
- How do I price my services?
- Can I afford to hire a new person, and what can I pay?
- Can I afford to offer benefits such as 401(k)?
- So, the big question is: Do you know whether you’re making money?
Here are four KPIs to help you find out.
1. Gross profit trailing twelve months
Trailing twelve months, or TTM, describes the time period of the past 12 months in any given point in time. Each data point represents the 12-month total for that date. It’s not month-by-month, but an overall view of the past year.
For example: If you’re looking at the gross profit TTM of your business for September 30, you would see a figure that represents your gross profit from October 1 of last year through September 30 of this year.
Gross profit is your revenue minus the cost of goods sold – or what it costs you to deliver your services. Two things comprise cost of goods sold: direct labor and direct materials. Direct labor is the labor cost to provide your service. Direct materials are the non-employee costs for a job, such as laptop rental, mileage reimbursement and subcontractors – those non W-2 workers not on the payroll.
Gross profit tells you whether you’re making your target dollars. It tells you the basic profitability of your product or service and is a key factor in how you price your services.
The key is to look at gross profit in both dollars and percentages.
For example: Your revenue last year was $100,000 and your gross profit was $50,000 – that’s a 50 percent profit (great!). This year your revenue was $150,000 (great!) and your gross profit was $60,000, which sounds great when you’re talking only dollars. But, although the dollar amount is higher this year, you gross profit decreased to 40 percent. What happened?
2. Net income trailing twelve months
Net income is what you have left after overhead expenses have been subtracted from gross profit. It’s the most important measure of your profitability
When looking at the data per month, rather than TTM, you get overly excited in your busy periods and terribly depressed in your bad periods. You end up living month-to-month. A TTM report will really tell you the economics of your business.
By looking at things over a 12-month period, it takes the seasonality out of the picture, so you don’t see the vast fluctuations that you see month-by-month. When you see the data points going in a downward trend on a TTM chart, you know you have a business issue.
This isn’t to say that you shouldn’t watch your net income month-by-month. You should. But, getting the bigger picture can put things in perspective.
3. Realization rate
It’s shocking how few people focus on this one. Realization rate is the total revenue divided by total hours worked by employees. This tells you how effective you are at pricing, staffing and managing your people. It shows you how efficient you are on each job.
This is especially effective when you are determining which projects or clients are worth keeping. If employees spend a lot of hours on a project or client that earns little revenue, you may want to put their time to better use. Your realization rate will tell you where your resources go and how much return on investment you get.
4. Cash Flow
Companies go out of business for three reasons: cash flow, cash flow and cash flow. Unless you have cash flow under control, you’re not going to grow your business and you will always be functioning in panic mode.
Are you collecting on money owed to you in a timely manner and do you have the money to cover your debts?
For a few extra tips read, How to Improve Your Cash Flow with Better Bill Collection.
If you don’t have a cash flow problem, then it’s time to focus on your cash flow forecast. A cash flow forecast should give a six-week look at where your money is coming from and where it is going. A six-week forecast gives you time to develop a plan if you foresee a time when your receivables won’t cover your payables.
Other things to watch
Having a dashboard where you can check on these and other key performance indicators in a chart form can help you manage your company’s finances better. Cash flow reports should be monitored weekly, with a look at the other three KPIs above on a monthly basis.
You should go back 24 months to get a good look at trends for the TTM reports.
Other reports that software can help you manage include:
- Credit card debt – It is the amount of unsecured liability incurred through a short-term revolving loan facility. This is where a lot of businesses get into trouble. Example: You obtain a credit card with an introductory interest rate of zero percent; but after six months, the rate goes up to 22 percent. And if you don’t pay in full each month, the interest charges will mount. You should work hard to not have credit card debt; it should be something that gets paid each month.
- Days of cash – How much cash you have today and the number of days of expenses you can cover with the cash.
- Cash on hand – Total amount of cash you have today, calculated as the sum of all balance sheet accounts.
- Working capital – Measures your company’s efficiency and short-term financial health by subtracting current liability from your current assets.
- Receivables – The amount your clients or customers owe you.
- Payables – What you owe to vendors.
- Cost of goods sold – All costs directly associated with making a product or delivering a service.
- Equity – The book value of your company that shows the residual interest in the assets you have after deducting liabilities, plus any claim to funds you have invested.
Need help with your bookkeeping and cash flow forecasting? Insperity Financial Solutions include bookkeeping, controller services, and intuitive software that put your company’s financial health back on track. Learn about Insperity Reveal®.