Running a small business: Tracking trends to stay out front

In part nine of their 10-part series, WADE GLASS and GARETH HOOLE discuss how to make sure your business is performing as well as it should


Over the past two weeks we have examined several business principles and if you have managed to address and apply all of the issues and recommendations in those articles congratulations. You have a head start on most other business owners and have set the foundations for the growth of your business.

Unfortunately, there's no time to sit back and rest on your laurels. "What now?" you say. To give you a clue, a more correct title for this article might be "Continual Performance Management". Throughout this series of articles we have emphasised that your business operates in a constantly changing environment.

To survive, you must rely on more than the basic financial information presented in your accounting system. A well constructed performance management system draws on financial and non-financial information to ensure the longevity of your business and to always strive for improvements.

Performance management is the process of continually measuring areas of your business that are critical to improvements and success.

Key Performance Indicators (KPIs) form the basis of performance management. They are any measure that can impact on the profitability of your business. Financial KPIs should be balanced with non-financial KPIs to give the most meaningful information to you in your capacity as manager of your business.

Financial KPIs

Your annual financial statements and internal accounting records should provide the basic data to compile financial KPIs. As a part of your year-end accounting service, your accountant will be able to provide and explain the various financial KPIs. However, as your business grows, an annual review will not be timely enough. Monthly or bi-monthly reports will become necessary for you to react to short term changes in your business.

As a business manager, you should at least have a basic understanding of financial KPIs. That way, you can take ownership of the way your business is being run, and really make your financial advisers work by asking difficult questions.

There are numerous ratios and KPIs and the business manager should avoid becoming too bogged down in calculating dozens of ratios.

What is more important is to regularly analyse a set of ratios, comparing current performance with budgets and historical results.

This will allow you to note the development of trends and to take remedial action where it is necessary before it becomes too late. Also, measuring the business's performance against benchmarks set by similar businesses can provide some very useful management information.

We were approached by the owners of small business who were disillusioned. Though working hard, seven days a week, they were not reaping the rewards they expected.

A simple analysis showed up some areas where they were going wrong but not realising it. They now hold regular monthly board meetings where they analyse the financial results of the business and take corrective action where required. As a result, they now work only five days a week.

Any business textbook can provide the variety of ratios which are available, but it is important that you measure the liquidity of the business, its profitability and productivity and the return on equity (ROE) it is providing to you.

Return on Equity

This indicates the return the owners are receiving from the capital they have invested in a business, expressed as a percentage.

You can compare your ROE to the interest rate you would have earned, had you simply put your capital into a bank deposit.

Ratios such as current ratio, number of days sales in stock, average collection period of debtors, number of times profit covers interest are just a few of the useful KPIs you should be considering regularly.

Another important KPI to measure is the business growth rate. An important point to note - a faster growth rate does not mean you are doing fine and no further analysis is required. Bigger is not necessarily better; it may indicate that you need to revise your cash flow forecasts, to determine if more operating capital will be necessary to fund the rapid expansion.

Whatever analysis you choose, the ratios must be recorded at regular intervals to provide trends. An analysis of trends does not require you to be a financial whiz kid, but does enable you to point out movements in ratios and ask your advisers why things have changed.

Non-financial KPIs

The performance management of your organisation cannot be based solely upon financial indicators. Measurement of non-financial KPIs is more likely to lead to increases in profit through efficiency or cost improvements. Although not measured in dollars and cents, these indicators have a direct impact on your bottom line.

Applying non-financial KPIs could be as simple as looking at the quantity of waste produced each month, the number of defective items produced, customer defection rates, production system outages, vehicle breakdowns and stock shortages. These are just a few statistics which will help you to run a more efficient business.

Let's look at the integration of the KPI aspect of performance management into an organisation, a restaurant for example:

* Step 1 - Identify the core processes in fulfilling external customer needs. What do customers want from the restaurant? They want good tasting food that has been prepared properly and is perceived as value for money. Diners want quality service from the waiters and other staff. They want a relaxing ambience - part of the dining out experience.

* Step 2 - Develop the desired outcomes from each function or individual that impact on the core processes identified in step 1.

This is where you determine exactly what it is you need to measure. The restaurant could record the number of times meals are sent back, the number of complaints to managers, the amount of tips (more tips indicate better customer perceptions of performance), the number of "regular" customers, the number of customers who have been recommended the restaurant by friends, the cost of ingredients wasted or spoiled, etc.

* Step 3 - Establish KPIs.

Effective KPIs are: objective and measurable; financial and non-financial; agreed upon by management and staff; able to be compared or to be benchmarked against other organisations; reported with other monthly reports. The KPIs should drive staff remuneration and performance measurement.

(The above steps to implementing KPIs were adapted from a report by James Hardie. The full report is available at www.bl.com.au/times/kpi-ful.htm).

KPIs are a useful tool for continual performance management. This article has outlined a basic illustration of the application of KPIs to your organisation and how you might go about using them.

The comprehensive development of a performance management regime is beyond the scope of this article, and will usually require the services of a consultant. However, now you are aware of the benefits of KPIs and the assistance they will provide in monitoring and improving your organisation.

Discuss with your financial adviser how these tools apply to your organisation. Merely by raising the issues addressed here, you are bound to come across some key success factors that your organisation can apply and benefit from.

* Wade Glass (assistant manager) and Gareth Hoole (associate director) are chartered accountants in the Corporate Recovery Services unit of Staples Rodway, Auckland. The views expressed are their own and not necessarily those of Staples Rodway.

TOMORROW

The importance of seeking professional advice and exploration of what you should expect from your advisers.