Rev­enue is Van­i­ty, Prof­it is San­i­ty, Gross Prof­it is the Dri­ver & Cash is King

“Van­i­ty is the quick­sand of rea­son.” - George Sand, French nov­el­ist, memoirist

Great rev­enue growth can bury a lot of sins.

If you sim­ply skim over your finan­cials when times are good, they may look fine on the sur­face – and be cat­a­stroph­ic under­neath. It’s not until you hit a few bumps in the road that you real­ize how bad­ly your com­pa­ny is actu­al­ly oper­at­ing – and then your van­i­ty, your pride in your achieve­ment — takes a tumble.

I’ve seen it more times that I care to remem­ber: super-smart exec­u­tives doing seri­ous dam­age to a com­pa­ny because they haven’t paid atten­tion to the right num­bers, nor real­ized the impli­ca­tions of some of their deci­sions. They all had good inten­tions and incred­i­ble pas­sion, but were mis­di­rect­ed by tak­ing a short-term view.

Here are three com­mon scenarios:

1. You’re dri­ven to hit a rev­enue goal, but com­pro­mise on gross margin
2. You achieve the gross mar­gin goal, but give it back with increas­es in over­head (G & A) expenses
3. You dri­ve and crush prof­it tar­gets, but run the bank account (or line of cred­it) dry.

Yes, I know that you think these are mis­takes that oth­er peo­ple make, and that you and your team are not at risk — and I hope you’re right.

So, what’s more important?

• Rev­enue
• Gross prof­it
• G&A/Overhead
• Profit/​EBITDA

All of the above — and the order of impor­tance depends on your com­pa­ny and your situation.

For most com­pa­nies it is usually:

1. Prof­it — the final indi­ca­tor of how well you run your own business
2. Cash – your bank bal­ance, and the flex­i­bil­i­ty it gives you to make the right decisions
3. G & A (over­head) expens­es – the indi­ca­tor of how much man­age­ment and sup­port required to oper­ate your busi­ness. This is the silent killer of profit.
4. Gross Mar­gin – the indi­ca­tor of qual­i­ty growth and how good your strat­e­gy is (increase per­ceived val­ue and low­er cost to cre­ate that value)
5. Rev­enue – makes you feel proud, and an indi­ca­tor of growth.

The key is to be aware of all of these, all the time — and to expect that well-inten­tioned exec­u­tives and CEOs can make deci­sions that adverse­ly affect these num­bers. The income state­ment and bal­ance sheet of most com­pa­nies will not make these things obvi­ous – until it is real­ly, real­ly painful.

So how do you ensure that your reports show over­sights quickly?

Look Fur­ther Back

Every quar­ter, I sit through the pre­sen­ta­tion of finan­cial state­ments for dozens of com­pa­nies, and get to see per­for­mance over mul­ti­ple years.

Here’s what I noticed: We usu­al­ly look at the cur­rent time peri­od (month­ly, quar­ter or year to date) com­pared to the bud­get and last year. While this can pro­vide some insight, it’s short­sight­ed – and can be dangerous.

Prob­lems can’t eas­i­ly be detect­ed with a 24-month view – but always can with a 5 to 10-year view.

In fact, 10-year trend report­ing is the best way to gain insight. I’ve seen all kinds of good and weak finan­cial and KPI report­ing, and the best solu­tion is the chart below: Month­ly data (weekly’s bet­ter), a 12-month axis, and 10 years of his­to­ry shown in per­cent­ages or ratios (for most measures).

Here are my favorites:

Look at Your Income State­ment from Dif­fer­ent Perspectives

If you look back over the last 5 or 10 years of most mea­sures of your income state­ments there can still be prob­lems buried beneath the sur­face that aren’t obvi­ous. So the best way is to look at some of the most sen­si­tive num­bers in your busi­ness mod­el, and track the changes as a per­cent­age of rev­enue, as a per­cent­age of gross prof­it, or on a per-employ­ee basis.

In some cas­es, some expens­es may look great as a per­cent­age of rev­enue, but when you look at it as a per­cent­age of gross prof­it, or on a per-employ­ee basis, they could be com­plete­ly out of whack. Every busi­ness mod­el is dif­fer­ent so when you track these over time, you’ll see the ones that actu­al­ly mat­ter most in your business.

Con­sid­er if any of these may be rel­e­vant for your business:

As a Per­cent­age of Gross Profit:

• Sales expens­es
• G&A/Overhead expens­es
• IT expens­es
• Peo­ple expens­es (salaries, ben­e­fits & consultants)

On a per employ­ee basis:

• Sales expens­es
• G&A/Overhead expens­es
• IT expens­es
• Peo­ple (salaries, ben­e­fits & consultants)
• Net income
• EBIT­DA

Look at the Trends of Your Oper­a­tional Met­rics (KPIs)

You can ana­lyze your income state­ments all you want, but the work real­ly hap­pens — and the great­est improve­ments or prob­lems seen — in your oper­a­tional met­rics, which reflect how well your busi­ness is being run at an oper­a­tional lev­el. Every busi­ness has dif­fer­ent mea­sures that mat­ter most, and here are some of the ones that every busi­ness own­er needs to watch.

These are sam­ple KPI’s for a few areas of your busi­ness. These should be in place (and reviewed reg­u­lar­ly) for all areas includ­ing HR, IT, Oper­a­tions, etc.

Finan­cial:

• Cash con­ver­sion cycle days
• A/R days
• A/P days
• Inven­to­ry days
• WIP days

Sales:

• Cus­tomer sat­is­fac­tion rat­ing at the end of the sales process (NPS or sim­i­lar measure)
• # of meet­ings per week with prospec­tive customers
• Time to close
• Close rate
• Aver­age Order Size
• Order GP
• Items per order
• Reorder rate
• Return rate

Mar­ket­ing:

• # of qual­i­fied leads generated
• Cost per qual­i­fied lead generates
• # of cus­tomers engaged
• Total audi­ence engaged
• Total dig­i­tal traffic
• % of dig­i­tal traf­fic that is mobile

Know What Great Looks Like in Your Industry

Mea­sur­ing your­self inter­nal­ly against your own his­tor­i­cal per­for­mance is excel­lent, and those trends will vary slight­ly. But, if at all pos­si­ble, it’s even more pow­er­ful to bench­mark your­self against the best your indus­try can do. Not the indus­try aver­age — because that’s an indi­ca­tion of medi­oc­rity – but the best.

In most devel­oped indus­tries, you can get these met­rics in trade pub­li­ca­tions, at indus­try con­fer­ences, or from con­sul­tants who are experts in your par­tic­u­lar industry.

The Right Data

No mat­ter what your role in the com­pa­ny it is your respon­si­bil­i­ty to under­stand what’s real­ly going on — and you can only do that well if you take into account the trends over the last 5 years.

Most lead­ers fail to man­age the right things because they don’t have the right data.

In a great arti­cle Ford CEO, Alan Mulal­ly, talks about review­ing over 300 charts in their week­ly meet­ings. He says that you can’t man­age a secret, and charts (like the ones I describe here) are the only way to get the key fac­tors on the table to run a busi­ness well.

The Chal­lenge

• What are the num­bers that you need to track over at least a 5 to 10-year time horizon?
• When are you going to make sure you review these – month­ly or quarterly?

If you need help, and more sam­ples and exam­ples to set up KPIs and finan­cial met­rics, let me know.

We are hap­py to help.