Rodger Stephens, CPA, CGMA is CEO of Prize Performance LLC. Prize Performance LLC is a consulting firm specializing in accelerating business performance for small to medium sized service businesses.
As a business owner, do you get overwhelmed with evaluating financial information about how your company is performing? There’s so much of it, it’s easy to get lost in what it means. When this happens, it becomes harder to understand what the financial information is telling you. Have you heard this song before? Let’s apply a concept that works well for many people in the past to help you with this issue. In the next few paragraphs, we’ll keep it simple by reducing the information overload. We are going to ignore this often vast amount of information and assume you have only three ways to measure your company’s performance. Then we’ll understand these three ways well so they can serve you and your creative ideas for improving the performance of your company. These three ways are:
- Cash Flow
- Profit Margins
- Revenue Per Customer
Thor’s Well, Cape Perpetua, OR
Cash Flow - It’s Like a Big Well
Think of your cash as a well of water. It rises, it falls, and it rises again. Any incoming cash such as customer payments, loan proceeds, and more, cause the well to rise. As you make payments for any purpose such as payroll, expenses, debt and any other payments, your well water falls. The measured amount of well water is your cash balance; all of the inflows and outflows are your cash flow activities. Healthy companies pay attention to their statement of cash flow, as this statement gives you a clear view of your entire cash flow situation…cash in…cash balances…and cash out. Your goal is to have a consistently solid and healthy cash flow each month, each quarter and each year. Doing this will slowly and steadily boost your cash to ever-higher levels. It’s common for some business owners to think they can understand cash flow by looking at the income statement. Because of how accounting works, your income statement may not give you a clear cash flow picture, as it only measures profit. Profit is a combination of cash and non-cash activity, so it’s very muddy picture if you are trying to glean cash flow from an income statement. For cash flow views, go to your statement of cash flow only.
How Much Water is Enough
You’ll want to examine your cash in terms of how long it will last you if your expenses are a fixed amount each month. This means if your current cash balance is $200,000 and your monthly expenses are $100,000, then the cash you have today will last you about two months. Healthy companies have at least a year of cash on hand.
It’s important to keep this amount of cash on hand because you can now easily fund the unexpected expense that inevitably happen. You can also fund the investment in additional resources to grow your business such as more marketing to drive customers to you, and the staff to serve them.
Where Is It
Your cash and cash flow are displayed on different standard financial reports prepared by your accountant or by an automated accounting software system. They can be viewed at your request with no advance notice. To get these, you’ll want to retrieve your Balance Sheet report. Your balance sheet displays ONLY your current cash balance. The Statement of Cash Flow will give you your current cash balance AND an accurate cash flow picture.
The Lesson To Learn
The lesson to learn - cash flow is a blind indicator of what’s happening. It’s blind because it will tell you your cash may or may not be flowing. It may tell you your issues reside in operating cash, investing cash or financing cash. It’s not going to tell you exactly what your operational challenges may be, or what to do to fix them. You need to receive any poor cash flow news as a hint that something needs improving. You should investigate to find out what needs fixing, and then design a strategy to address the issue. You’ll need to re-measure your cash flow later to see if your strategy worked!
Profit Margins - It’s Like a Big Scoreboard
Like the score of two teams playing a football game appearing on a scoreboard in the end zone, your profit margins are an easy way to score your company’s performance against any opponent. They also give you an easily compared measurement of your company performance to what is an average performance in your industry. Even if other companies are larger, or more complex, comparing your margins to theirs can still be done. Doing so will tell you, reliably, if you are doing better, the same or worse than the company you are comparing against. Most industry associations provide industry wide margin information about gross profit margin and net profit margin measurements. Go to your industry association website and download these reports. You now have your entire industry average to measure against in one comparison! Because these reports assemble many companies’ margins to give you the industry average, then this is your reliable average performance measurement for your industry. So go ahead, compare your company’s profit margins to the profit margins of your industry or even a public company that does something similar to you. See how you score!
What’s the Benchmark
For service companies, meaning companies where the labor of the company generates most of the revenue, standard measurements are called benchmarks. You should judge your company against these benchmarks each month, each quarter and each year. What are these standard benchmarks? If you are a service company, and you are performing at an average performance level, your gross profit margin benchmark is 50% and Net Profit margin benchmark is 25%.
How Does My Company Score
Now that you know these standards, take your own company profit margins and compare to the 50%/25% benchmarks. Are you above? For each? Congratulations, you are performing well and better than most! You are doing something unique and different that few competitors are doing! If you are below, then you have some work to do. If your industry shows better margins than you, then your competitors are doing something you aren’t. You know great margins are possible. Why aren’t you doing something to increase your margins?
What it Tells You
Just like cash flow, profit margins will not tell you the specific issue needing improvement, but they will tell you a business adjustment is needed. It’s your job to investigate and find out what the adjustment is. Once you determine the area needing improvement, you can develop a strategy and make it happen.
Where Can I See It
Profit margins are standard display options on all income statement reports. Your accountant or your automated accounting software system can provide these at your request. If you are not viewing these and comparing your performance to the industry standard performance, please begin doing this regularly.
Revenue Per Customer – Many Idea Lightbulbs
Revenue per customer is like that great idea light bulb appearing over your head at just the right moment, only these ideas are so big and so many, the light bulb becomes a brilliant bank of lights like the ones you see at a stadium. Revenue per customer will give you multiple, highly valuable insights you didn’t now existed. For example, a high measure of revenue per customer may tell you your customers like your services enough to buy more. A low measure may tell you they don’t repurchase your services. Many more insights can be learned such as your team’s ability to sell and how many products or services, on average, each customer purchases. All of this information is highly valuable in leading you to create successful strategies for marketing and selling to your customers and preparing your sales force for success.
What’s My Revenue Per Customer
For most companies, calculating your revenue per customer is simple. For any period of time, I recommend each month, take your total revenue dollars and divide it by the total number of customers you served that month. Be sure to keep all dollars and customer counts within the month you are working on. Accurate dollars and counts are desired here. Also don’t be so quick to assume other time periods such as a quarter or a year are the same figure. You must calculate these other time periods independently, using this same formula, as your results will vary from any month’s measurement and will give you different insights and different longer-term trends. For now, let’s just follow a monthly measurement. Your company’s specific business model, your industry and other factors will influence your revenue per customer up or down.
Revenue per Customer = Monthly Revenue / Monthly Number of Customers
What Does It Tell Me
Now let’s say you’ve measured your revenue per customer. Let’s also say you’ve done this calculation for each month for the past twelve months. Now it’s time to introduce your own benchmark to compare. Because your sales per customer are custom to your company, and not easily compared to other companies, you can find your benchmark price by looking on your own price list. This may be your service with the lowest price, your introductory service price or your single most popular service price. Select one of these three. Now take your revenue per customer and divide it by your benchmark. The result is your multiple. How many multiples of your benchmark price is your revenue per customer? The general rule is the higher the multiple the better, the lower the multiple, well, work is needed to improve. If it is close to 1, then this is a sign of poor performance because your customers are only buying one benchmark service from you, and they aren’t buying more. Under this scenario, you are spending considerably to get customers, and to serve them, but you are not seeing good customers support your business by purchasing more services. On average, healthy companies see a multiple of at least 10. Very successful companies see this much higher.
Multiple = Revenue per customer / benchmark price
How Can I See It
Because trends aren’t so visible by looking at a row numbers in a spreadsheet, you will need to create a chart to display the rise and fall of each month’s revenue per customer in a visual way. Do this each month and display your entire monthly history over time. As you calculate revenue per customer each month, add each new month to the chart. As the months, quarters and years go by, you will be able to see, with clarity, the patterns of your customer’s buying behavior. Some months or seasons this may be up. Other months or seasons, it may be down. This visual pattern is worth GOLD to you. Why is it worth gold? Because if shows your customers buying behavior. If you can understand your customers buying behavior, then you can begin to create strategies to influence it in your favor!
The Executive Summary
These three different figures can give you a huge amount of information to judge your business health. They also lead you to ideas to improve your business performance. Use them regularly, and you are on the way to a healthier and more profitable business.
- Keep a steady, consistent cash flow to accumulate cash
- Keep at least a year’s worth of expenses accumulated in cash
- Cash flow may indicate an issue, it’s your job to find out what the issue is
- A way to know if you are performing well or not
- You should meet or exceed 50% Gross Margins and 25% Net Margins
- Profit margins may indicate an issue, it’s your job to find out what the issue is
Revenue Per Customer
- Revenue per customer can give you multiple, highly valuable insights
- Do everything you can to exceed a multiple of 10
- When you discover what needs improving, create a strategy to improve it
As you may see by now, the formula for success shows a pattern! In case you haven’t spotted the pattern, here it is: The figures you read on ANY financial reports are giving you clues to your business health. It’s a great idea to look at the figures as if you are Sherlock Holmes looking at clues to a crime: what are these figures saying about the state of my business health? Once you know, I recommend creating a strategy to turn any bad health into good health. If you want to be a great company, don’t wait for bad health, aggressively turn your average health into great health! Your business success lies in continually repeating this process to improve your company performance!
I invite you to contact me if you have questions!
Rodger Stephens, CPA, CGMA
Prize Performance LLC is a consulting firm specializing in accelerating business performance for small to medium sized businesses. Contact Prize Performance LLC today to take your business to new places!