When times get tough it’s natural for business owners to focus on cutting costs and trying as hard as you can to increase revenue, but there are many other drivers of profit and ultimately cashflow, that with a few tweaks and close monitoring, can achieve significant improvements in both profit and cashflow.
Given a large number of businesses are feeling the pinch at the moment, we thought it would be a good time to share our thoughts on some of the key profit and cashflow drivers to look out for in your business.
1. Revenue Growth
An increase in Sales is often the first strategy a business owner will look at when they want to grow their business, however revenue growth in isolation is not always going to lead to more profit and better cashflow. In fact, I have seen it do quite the opposite.
Depending on your businesses working capital cycle, an increase in Sales will cause more strain on cashflow requirements whilst you are funding that Sale (ie between paying for the goods or labour and receiving payment from your
Customers for that stock or work).
If your plan is to increase Sales, then be prepared with a plan in place to increase your available working capital before-hand so you don’t get caught short in your growth phase.
Also don’t lose sight of your other important drivers. A focus on generating more Sales is important as long as all other KPI’s either remain equal or improve at the same rate.
2. Average Sales value
This is an often overlooked KPI and one that can eat away at your margins over time if not monitored closely.
Depending on whether you sell goods, services or both, your average sale value is the average revenue you generate from each item or customer or the average rate you charge for each hour your staff are working (service businesses only).
If you don’t apply regular price increases to keep up with increased input costs then over time your margins will erode. Many business owners are too afraid of losing customers to increase their prices but small CPI increases of 2-3% each year will hardly be noticed, if not expected!
Keep in mind a small increase in prices (assuming no change to other KPI’s) can make a massive impact on your bottom line. For example a 5% price increase to a business turning over $1m per annum means an extra $50,000 net profit (before tax)!
3. Cost of Goods Sold / GP%
A reduction in Cost of Goods and/or creating efficiencies in your operating processes can have a significant impact on your gross profit % which will flow through to your bottom line (assuming overheads remain constant).
It might be negotiating better deals with suppliers or taking the time to “shop around” for a better price. It might be reviewing your processes and driving staff efficiency.
Whatever it is, this is an area that needs constant attention and in many cases, a longer term focus. You cannot necessarily create instant savings in this area and it might be that you need to increase costs in order to generate longer term productivity gains.
The key here is to have a long term strategy that focuses on driving improvements in your Gross Profit margin. Again a small increase in GP% can have a significant impact on your profitability.
4. Overheads relative to total turnover
Overheads are generally a lot easier to manage than direct/variable costs of sale however a regular review is important. Mostly overheads are fixed (or stepped variable ie they stay fixed for a certain size business then they jump up to the next level) such as rent and on-costs, admin staff wages, IT, insurances, accounting, marketing etc.
It is important to monitor overheads relative to your total turnover (revenue) to ensure that the % of overheads to revenue stays consistent or is reducing. If you are in a growth phase then you’d be looking to continually reduce your overhead % (until you get to a certain size and have to move to a bigger premises or put on more staff etc).
Having an overheads budget in place and monitoring actuals against budget is the key to staying in control. Negotiating fixed fee contracts for overhead expenses can also be a good way of controlling costs in this area.
5. Accounts Receivable Days
Accounts Receivable (AR) Days are the number of days on average that your Customers take to pay you once you’ve invoiced them. If you are a business that sells on terms (ie non cash based business) then AR days are critical to your cashflow.
Selling more goods or services is not going to help your cashflow position if your Debtor days are trending upwards.
Having a solid Debtor collection policy and process in place, and consistently following it, is critical, as is getting invoices out as quickly as possible, dealing with any issues or disputes swiftly and being upfront with your terms and conditions.
6. Accounts Payable Days
Accounts Payable (AP) Days can also be an opportunity to better manage your cashflow. Depending on your working capital cycle and how long you have to “fund” your Sales (ie number of days between paying for stock/labour to receiving payment from your Customers), stretching out AP days can be a big help to your cashflow.
I’m not suggesting paying Creditors late but negotiating payment terms and using those terms can really assist your cashflow management.
7. Inventory/Work in Progress Days
Another critical element of your working capital cycle that can make a huge difference to your cashflow is inventory or work in progress (WIP) days. This is the number of days between purchasing stock and selling it (ie how long it sits on the shelf) or the number of days between your staff working on a job before you bill it (this is WIP).
Focusing on turning over your stock quicker, or completing jobs quicker (or invoicing progress payments) can make a positive and signifcant impact on your cashflow.
Having a good inventory system or job management system will go a long way to monitoring and improving this area. Being able to easily and accurately monitor stock levels and forecast requirements and/or monitor your staff’s progress on jobs and get them out the door quicker will help speed up your cashflow cycle.
Will all of this said, KPI’s in isolation are not much use. You need to firstly have a plan (ie a budget or benchmark) to target and then you need to continually and consistently monitor your KPI’s against your targets and last month/year if relevant, so you can quickly identify when any of these indicators are getting off track. A quick tweak or correction here or there may be all you need but if you don’t catch it soon, it could be detrimental to your business or you could miss vital opportunities to make more profit and have better cashflow.
So what next? Many of our clients already have KPI reports in place and are regularly monitoring these critical statistics.
We have found a number of our clients who have had these reports in place long term have been far better equipped to manage the tough conditions that a lot of business owners have experienced of late, than those who have not.
Having accurate and reliable financial information at your finger tips when you need it most, is vital to the long term survival of any business. So if you don’t have a budget and KPI report in place please contact me so we can get this set up for you as soon as possible.
Remember, information is power and having that information gives you peace of mind and control over your finances so you can stop worrying and start making the right financial decisions!