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:
- You’re driven to hit a revenue goal, but compromise on gross margin
- You achieve the gross margin goal, but give it back with increases in overhead (G & A) expenses
- 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?
- Gross profit
All of the above – and the order of importance depends on your company and your situation.
For most companies it is usually:
- Profit – the final indicator of how well you run your own business
- Cash – your bank balance, and the flexibility it gives you to make the right decisions
- G & A (overhead) expenses – the indicator of how much management and support required to operate your business. This is the silent killer of profit.
- Gross Margin – the indicator of quality growth and how good your strategy is (increase perceived value and lower cost to create that value)
- 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
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.
- Cash conversion cycle days
- A/R days
- A/P days
- Inventory days
- WIP days
- 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
- # 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.
- 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.