I just read a very simple, but clever and thought-provoking article by Ken Krogue on the Forbes blog. It was entitled 5 Things Business Can Learn from a Tree and you can read the full article here.
The five principles he wrote about were:
- Find Water
- Grow
- Branch Outward
- Change
- Watch the Patterns
It is principle number 5 that I want to dwell on for a short while.
Why is it that so many SMMEs don’t track their results? Sure, they may look at their Income Statement and Balance Sheet each month, but they don’t “watch the patterns”. They don’t track the trends, measure year-on-year numbers or examine KPIs against target. Very difficult then for them to meaningfully analyze what works and what doesn’t!
Analyzing data takes the guesswork out of moving forward. The analysis and interpretation of financial statements and other company data is useful in achieving several objectives:
1) Evaluating past performance
2) Assessing current status
3) Predicting future potential
4) Taking the right decisions to maximize profits and resources
Watching the historical patterns can provide a basis for a company’s response to current and future situations.
So, which patterns should a SMME watch? There are many but, arguably, three major patterns to track could be summed up as:
1. Actual vs. Planned Performance
It is no good to ‘hit and hope’ each year. You need to plan the results you want to achieve. Then measure actual performance against the planned performance. If you had fewer sales than planned, you should know or find out why. Were there significant changes in your top selling items? Did particular regions perform badly? If any costs were greater than planned, you should know or find out why. What were your top 5 expenses?
Every dollar that is different to what you planned should be analyzed. You may need to scale back or focus better on one thing or sort out staff issues or identify new opportunities.
2. Trend Analysis
By comparing current performance to previous performance you can evaluate which areas of your business have changed, and by how much.
- Are sales trending up? Sales are crucial to generate cash, so this trend needs to be closely monitored.
- Are certain costs trending up or down?
- Are profits trending up?
- Is your cash flow improving? Managing cash flow properly is important to the success of any organization. It is really important to constantly monitor cash flow so as to be aware of any potential problems and be able to stop any shortages of cash from happening. The aim over time is to grow cash reserves – after all, cash offers protection against tough times, and gives companies more options for future growth.
Then you need to determine why the change occurred, whether positive or negative. It is likely that you will need to change your planning if you see a new trend emerging.
3. Industry Comparisons
Financial ratios not only allow you to compare your business’s performance to others in your industry, but also to standards set by your banker, your investor(s), your advisory group, or even yourself. Some of the more common financial ratios to analyse are:
- Balance Sheet Ratios which typically measure the strength of your business
- Current Ratio —one of the most widely used tests of financial strength, calculated by dividing Current Assets by Current Liabilities and used to determine if your business is likely to be able to pay its bills.
- Quick Ratio — sometimes called the “acid test” ratio because it concentrates on only the more liquid assets of your business, calculated by dividing the sum of Cash and Receivables by Current Liabilities.
- Working Capital — watched very closely by bankers as it deals more with cash flow than just a simple ratio, determined by Current Assets minus Current Liabilities.
- Inventory Turnover Ratio — tells you if your inventory is turning over fast enough, calculated by dividing Net Sales by your average Inventory (at cost).
- Leverage Ratio —another of the analyses used by bankers to determine if your business is credit worthy and often the calculation a supplier to your business will make before extending credit to you, it shows the extent your business relies on debt to keep operating, calculated by dividing Total Liabilities by Net Worth (total assets minus total liabilities).
- P&L Ratios
- Gross Profit Ratio — the most common calculation on your P&L, simply your Gross Profit divided by Net Sales. It is desirable to watch the trends and not let this number move too far from your target which you may set based on industry guidelines.
It is important to watch the above three patterns to adapt to market changes and plan for future growth in your business. It is obviously easier for a mid-market enterprise with more resources to achieve this, than for a small business owner who is constantly juggling his or her time to effectively manage multiple projects, relationships, and sales opportunities. No matter what the size of the business though, it is desirable that more time be spent on analyzing the information, as opposed to pulling it together.
Enter Sage Intelligence, a module of your Sage ERP/Accounting solution, which empowers you to quickly and easily obtain information from across your entire business, in a variety of customizable Excel reports. With this reporting tool, you will get improved visibility of the patterns in your organization. And improved visibility gives you the capability to make better decisions for the future success of your company.
