20 Jun Business Strategy & Financial Statements: Fixing the Disconnect
Financial intelligence plays a big part in running a successful business, however, traditionally in companies the financial statements are somewhat segregated off to the accounting department. How effectively you measure your business strategies can mean the difference between a thriving company and a failing one.
To do this properly, you’ll need to integrate the business financials with your marketing, sales and operations. Strategy needs to become connected to the end financial results. Your KPI’s are incredibly important – but only the right KPI’s. With an abundance of data, how do you determine what to measure?
Here are a few critical things that every business needs to be measuring – and luckily, it’s fairly straight forward.
Aggregate Customer Analysis
By aggregating a few key customer metrics, you can easily track and uncover important operating realities that typically get hidden in the P&L. See the following example case:
# of Customers: Easily obtainable for most companies.
Frequency: How many times on average each customer/client pays. For contract-based businesses like the example above, I have the frequency set to 12, with the transactional value as the monthly fees. This way, we can multiply customers x frequency x value to get a rough annual revenue (allows us to do a sanity check ensuring our averages aren’t way off).
Avg. Transaction Value: You can obtain this by pulling your invoicing and simply running an average. In this example, it’s for each month.
Avg. Gross Profit: Take straight from your P&L.
Avg. Transaction Overhead: Total up all your fixed and variable costs (all monthly operating expenses) and divide by the number of transactions.
What we have now is a basic snapshot of operations – where we can tell if business is really trending up or not. In contrast, by looking at the regular P&L – we may miss some pretty big issues. For example, revenue and profitability may be up, but what if our customer count changes drastically? How many actual transactions does our revenue consist of? In our analysis here, these risks are identified.
We can now begin to dig deeper and go into the data that makes up these numbers.
Who are your most profitable customers? Are they good, engaged customers? Where did they come from? Which customers aren’t worth the money, or worse yet – losing you money? These questions are answered by doing a profitability mapping at the customer level.
Customer Profitability Mapping
Each business will be different in arriving at profitability data by customer. However, the trickiest part is usually determining how to allocate overhead, employee or material costs.
For employees in a service business – hours most likely need to be tracked by project and customer.
For manufacturing or project-based, an accurate cost of goods sold needs to be maintained, with the heavy overhead expenses allocated in proportion.
Once we have profitability by client, we can then rate each client by quality on a scale of 1-10. This is a bit harder the more customers you have, but for most small to medium businesses with recurring revenue, it’s doable.
By using the profitability and quality score, we can now create a mapping of 4 quadrants:
Your mapping should look something like the above. High profitability and high client quality in the upper right, negative profit and low quality to the lower left.
By doing this every so often, we can now see trends over time that could identify future problems before they occur.
This also allows us to identify high quality/low profit clients that we need to be cross-selling and working on improving.
We can now see “at risk” quality clients in the lower right that we need to remedy before we lose profits.
And finally we can see the ones who are low quality and losing us money at the same time – those should be eliminated immediately.