As everybody knows, nearly everyone has advice for the CEO/business owner, some of it sound, and some not so sound. But when all is said and done, when it comes to making a profit and translating that into cash in the bank, there are a handful of basic financial questions that you need to have the answers to, after you’ve put the monthly financials in the drawer.
Let’s get down to basics – the basics many businesses are unaware of. Here are the 5 most important financial metrics every CEO should know about their business, large or small.
- How much profit do you really make on each of your 10 largest customers? Why? Because the profit you make on those big customers determines in large measure the profitability of your business. Consider any special price concessions you might give them in appreciation for their business. Special attention to them in delivery, warranty support, or other customer service? Do you extend payment terms or wait longer before you call Accounts Payable? Each of these add-ons has a cost, in people, time or cost of money. And if you’re giving those concessions because you’re building a relationship that will pay off “later,” ask your customer when they will be willing to pay you more for what they pay less for today.
- How much does each product you sell really cost you? I am amazed at how many companies figure their all-important Gross Profit on a product by deducting from the selling price only the direct costs of manufacture or purchase. Often this is calculated for an entire department, or even entire factories, rather than for the individual product itself. Unfortunately, this is rarely the true cost of a product you sell. Consider the costs to receive, package, warehouse, and deliver the product. How about servicing the warranty on its performance? The development cost if it’s your proprietary product? Your most popular item could be a loss leader without your even knowing it.
- How quickly does your inventory revolve, or turn over, during a year? Funny things happen to inventory that doesn’t move out of your warehouse pretty quickly. It disappears. Or it breaks. Or it becomes old, obsolete, or generally unusable. Or it just gets misplaced or lost, to be found soon after you’ve bought more. All of these results take money out of your pocket without giving you any benefit in return. Why know this item by item? Because expensive items that don’t move may be hidden by fast moving commodity items on your floor that have much lower margins.
- How quickly do your receivables get collected? This sounds like a no-brainer to most folks including, I’m sure, nearly all my readers. So, ask yourself this: What is your average days’ sales outstanding (shorthand – “DSO”)? Need to look it up? Hm-m-m-m. Too often we believe the concept but don’t follow the practice. Collections get out of hand without our realizing it, because we’re busy selling more and “managing the growth.” And watch your A/R aging trends as well, because old balances look the same as new balances in a DSO calculation, and the older those balances, the less of them will be collected.
- If your business does what you expect it to, when will your cash reach its highest point of the year? The lowest point? And how much cash will that be, roughly? Many small business CEOs track cash flow by following net income and the bank balance, neither of which is going to be very useful in predicting future cash needs for most businesses. Capital asset purchases, growth in inventory, receivables and payables, debt service, capacity expansion – all can have a profound influence on future cash balances, and all are reasonably predictable with a little work.
If you don’t have the answers to these questions, and that bothers you, it might be time to call for help.
We are Your CFO for Rent.