As many of us have encountered, there are a multitude of numbers, ratios, and other metrics that need to be calculated and monitored in your business. Trying to manage all of these can become frustrating and confusing. Sometimes, especially during good times, we wonder, “Why bother?” things are going well. During more difficult times we feel like we’re too busy reacting to circumstances to worry about all the numbers and we find ourselves primarily focused on sales. That’s why this blog is so important to your business.
In your business, it would be pretty easy to come up with 30 – 40 metrics that help monitor business performance and identify the need to course correct. The question becomes, “Which ones really matter?” In reality, they all matter, but not necessarily at the same time. The metrics you choose to monitor, on a regular basis, or on an as needed basis, need to provide you with a quick perspective on a particular area of performance. Therefore, the 3 we choose in this environment may not be the ones we use for other perspectives.
In times of crisis, it all becomes about operations and from an operational perspective, there are 3 key metrics you should be monitoring. These metrics provide critical insight into Liquidity, Sales and Efficiency. If you’ve read some of my other blogs or attended some of my webinars you’re probably saying, “Wait a minute, what happened to the focus on Liquidity, Profitability, and Capital?” Well, they’re still there and still very important, but when it comes to managing day to day operations your monitoring starts here.
If you research these categories, you’re likely to find 6 – 10 different ratios for each. Don’t worry about that now. Each of those has a very specific focus and is important within the context for which it is used. Let’s look at the most important three.
For Liquidity we use the Quick Ratio (Quick Ratio = Liquid Assets/Current Liabilities), for Sales we use the Conversion Ratio (Sales/Leads x 100) and for Efficiency we focus on the Efficiency Ratio (Operating Expenses/Revenue x 100). Now, let’s take a quick look at each of these and determine why they’re the most important.
As we know, “Cash is King.” That speaks directly to Liquidity and our ability to continuing meeting our financial obligations through the operation of the business. The Quick Ratio (Liquid Assets/Current Liabilities) gives us the most immediate perspective and looks like this:
QR = CE + MS + AR / CL
CE = Cash & Equivalents
MS = Marketable Securities
AR = Accounts Receivable (collectable within 90 days)
CL = Current Liabilities
The result tells us how much liquidity we have to meet current obligations. If the result is less than 1, say .66, it’s telling us that we only have 66 cents to meet each $1.00 in obligations. If the result is 1.20, we have $1.20 to meet our current obligations. Hence, this provides a quick and clear perspective on liquidity.
The next area of focus is Sales. It’s easy to just measure total sales per period and sales trend, but a more meaningful perspective involves your conversion rate. Using the Conversion Ratio (Sales/Leads x 100) we can see how well the sales funnel is operating. During challenging times, the ability to convert a lead into a sale becomes more difficult. If we understand the underlying metrics of our sales funnel the Conversion Ratio gives us the ability to know how much we need to adjust our sales process or behavior.
For instance, if we historically secure 3 sales out of every 10 leads, we’d have a 30% conversion rate (3/10 x 100). If that conversion rate falls to 20% (2/10 x 100) we know that we need more leads to get back to the 30%. How many more? Well, we need 3 sales, and we’re converting at 20%, therefore, 3/.20 = 15. We now need 15 leads to get to the 3 sales. With this information we implement additional efforts to increase the number leads and/or the conversion rate. The point is, that this one simple metric keeps you focused on generating an appropriate level of sales.
Finally, we look at our Efficiency ratio (Operating Expenses/Revenue x 100). This ratio gives us a perspective on when we may need to adjust our operating expenses. During challenging times, we typically experience reduced revenues rather quickly but, for a variety of reasons, we are unable or reluctant to reduce expenses as quick as the impact on revenues. So, if in normal times our operating expenses are $100,000 and our revenue is $ 175,000, we would have an efficiency ratio of 57%. ($100,000/$175,000 x 100) In essence, we are spending 57 cents of every revenue dollar in operating expenses. As revenue falls and operating expenses are stable our efficiency ratio will increase. That’s not a good thing. The lower your efficiency ratio, the better. With this information you can quickly focus on areas to reduce operating expenses, thereby ensuring that the organization continues to generate liquidity, the key to survival.
One Last Thought
Always, remember that any ratio can be improved by changing the numerator or the denominator. Be sure to consider either or both when managing these ratios. That will maximize your opportunities for improvement.