Key Performance Indicators and Valuation Enhancement
When the goals are to improve performance or enterprise value Key Performance Indicators, or KPI’s, are one of the first places to look.
How do owners measure progress? Besides the big 3 indicators of revenue, profit and cash flow, one should look at how the departmental goals contribute and are connected to the big 3. The key here is that “What gets measured gets improved”.
When developing KPI’s, they need to be to be closely related to the primary activities which drive revenue, profit and cash flow. They should also be easily reportable and objective.
For revenue, most companies will look at how many customers they get, or new sales for the week. The challenge is that these are not activity-based indicators. My recommendation is usually built around the sales activities. Sales rep calls per day or meetings per week would work better as these are controllable activities. These are easily measurable and can be influenced quickly. They also help focus the coaching between the manager and the sales rep.
Operational KPI’s are the profit drivers besides price. Businesses need to get to the core operational drivers of cost. For a service company, it is usually the productivity of the staff. A cleaning service or landscape service would have expected total hours per job. How did the company perform against expected productivity? For a manufacturing company, labor is important, but we will also give the use of raw product a close review. How much waste is there in rework, failed testing of product, recalls, complaints. Indicators and tracking in this area are critical.
Good cash flow is critical to the success of any company. Days cash on hand, days sales outstanding, and inventory turns are all great KPI’s to review. Depending on your business, you may only need to track 1 or 2. Day’s cash on hand is an indicator of how long you can go without getting paid. This was severely tested in 2020 with the Covid shut downs. The old benchmark was 2:1 – twice as much cash as current expenses. I believe this will go up for some businesses going forward. Day’s sales outstanding – DSO – for a business which does not collect full payment at the time of service – this is a critical number. In the medical world, this is the biggest measure besides productivity. Nothing steals your breath faster than when your DSO goes up by 10 days. The third is Inventory turns. Each business which sells product, should evaluate inventory turns. Inventory is cash on the shelf. Check this against industry standards and work with your vendors to improve this.
If a company does not have Key Performance Indicators for their sales, operations and cash flow management, then the owner and management likely do not know the true efficiency of their company. This limits the efficiency, profitability and value of the business.
About the Author
Mark Fiorini is the Value Enhancement expert at ValueCap, Inc. He has 30 years’ experience in developing and improving all types of businesses.
Copyright: ValueCap Inc.