If you’re like most Small Business owners in America today you’re using Intuit’s QuickBooks product to manage your finances. QuickBooks has something like 80% of the small businesses in the United States including mine.
One of the drawbacks of using QuickBooks is that you get stuck with their reports, and their reports are dry, emotionless accounting reports. If you’ve got a background in Accounting then you can use the big 3 reports (Balance Sheet, Profit and Loss, and Statement of Cash Flows) and have a pretty good idea of the state of your business at any given time. Unfortunately, many Small Business owners don’t have that background and struggle with understanding what’s going on.
Let’s face it: financial reports suck. I’d like to share with you some of the Key Performance Indicators we use that QuickBooks doesn’t give us and how you can calculate them on the regular. The purpose is to help you think about those boring, drab numbers in a new way and hopefully gain a better understanding of where your business stands.
Our Baseline Number
When I started in the business we obsessed over the easiest to understand report: the Profit and Loss Statement. This one is simple because it tells you how much money you cleared each month. The problem with it is it doesn’t tell you how well you’re actually performing over time. It’s even worse if your business is seasonal or just very sensitive to outside factors. You need a baseline that is going to give you a handy reference to tell you where you are in comparison to the past.
We settled on Average Sales Per Day. This one is easy for us because we work Monday – Friday, so we know that our year consists of (on average) 252 working days (365 – 104 Saturdays and Sundays +/- leap day). That means I can take the last 12 months sales and divide by 252 to get my Average Sales per Day. This number now becomes a reference for many, many other calculations.
We also calculate the Average Sales Per Day This Month. This is simply Sales / Number of Working Days in the Calendar Month. This gives a more normalized reference and becomes easier to compare to our Baseline Number.
Accounts Payable & Accounts Receivable
Accounts Payable refers to that money that you owe other vendors. It’s commonly denoted as A/P. I hate A/P because it’s a big measure of how much money I’m not going to take to the bank. Our old way of management meant that we waited until we were “pretty sure” that all of our vendors had sent us
Our old way of management meant that we waited until we were “pretty sure” that all of our vendors had sent us, run a P&L report, and try to figure out how much of that profit we were going to actually be able to recover. The major problem with this method is that it lacks the context of knowing what has and has not been paid already, including the previous months. We want contextual numbers.
Now that we have our Baseline Number we want to put as much as possible in the context. If you’re following the same Monday-Friday schedule as we are then we know you’re dealing with, on average, 21 working days in a month. What if we could reference our A/P in terms of days?
If you’re a QuickBooks user then you need to run your “A/P Aging Summary” report. You can take the total from this report and divide by your Average Sales Per Day and get “Days Payable Outstanding“. This gives you a reference as to how many days of revenue you need to pay for all the crap on the books right now. I’m lucky enough to have someone working in Accounting full time so this is part of our “End of Day” procedure. I get an email with the report from QuickBooks as well as the calculated Days Payable Outstanding plus Deposits, Bank Balance, and whatever else I think is important. The whole process takes 5 minutes.
In Accounts Receivable (A/R) you can create a “Days Receivable Outstanding“, but if you’re a company who invoices your work you might find that this number doesn’t really help as it naturally goes down over the course of the month. If your terms are NET 30 then this may be a good number for you. If you’re a DUE 10th type of place it’s less important. You may choose to calculate it either way just to have a consistent reference.
I personally find that a more important measure of A/R is the percentage collected, so we have a report generated each morning that includes this. This allows us to set clear and concise goals for collecting money from our customers. For example, you can set a goal to have collected 80% of all outstanding A/R for the previous month by the 15th of this month. Your results and goals will be different, but at least you’ll know where you stand.
To calculate percent collected you just need Income (last month) and Receipts (this month): Receipts / Income = % Collected.
On our report, we show the last 5 months and the level of collection for each. That’s 150 days. Anyone who has made it to 150 days automatically gets sent to collections. We have a different procedure for dealing with each of these stages (30, 60, 90, etc) so we get results. You’ll want to figure out how to handle each of these your own way, but do make a decision and stick to it. Inconsistent collection practices lead to lost time and money. The “squeaky wheel gets the grease” as they say.
We break up customers in two ways in a few distinct categories. The two ways include looking at the 12 Month Spend for the various categories and the Average Spend for the various categories. In this way, we can easily see how the total 12 Month Income compares to the spend in each category and we can view Average Spend in terms our Baseline Number. Let’s look at some examples.
Categories – Quartiles, Top 10, Top 50, and more
How you break your customers up is not as important as the actual way in which you monitor them, but I do have some recommendations.
If you’re familiar with the Pareto Principle (commonly known as the 80/20 rule) then you’ve heard the old saying: 80% of your blank comes from 20% of your blank. Personally, that’s a tad rich for me with our customer base, but I guess it depends on your expectations. I do, however, use it as a reference. I want to know what percentage of our business comes from what portion of our customer base.
To calculate this you need to have a list of all of your customers and their spend for the time period. I recommend sticking with the 12 Months prior. You’ll want to rank them in order from highest income to lowest. You’ll want to do this in a spreadsheet like Microsoft Excel. For the sake of argument, let’s say you had 100 customers. Do the Top 20(%) account for 80% of your total income for the time period?
Now that you’ve got all of these customers in a spreadsheet, let’s take the time to break them in to Quartiles. In this imaginary list we have an even 100, so it’s easy to break it up in to blocks of 25. At the top you have the Top 25% Customers and at the other end the Bottom 25%. We call these 1st, 2nd, 3rd & 4th Quartiles. It is understood by everyone in our organization that this encompasses all of our customers. We use this to track the performance of each segment to see if they’re improving. We tend to spend a lot less time worrying about customers in the Bottom 25%.
We also track our Top 10, Top 50, and Top 100 in the same way. Each one is presented first in terms of total spend during the 12 months (their literal dollar amount) and also in terms of our Baseline Number.
For Quartiles, the formula is: (Total Revenue from Quartile) / 12 Months / (# of Customers in Quartile during period)
For Top XX, the formula is: (Total Revenue from Quartile) / 12 Months / (# of Customers) (eg. 10, 50, 100)
If you’re lucky enough to have a firm grasp of your inventory on hand, then it’s easy to convert that number to our baseline of days. Even better it gives you a frame of reference for when you want to reduce inventory on hand and you want every little bit to count.
Inventory / Average Sales Per Day = Inventory Days
Other Important Indicators
This is by no means a comprehensive list. If I’ve peaked your interest and you’ve wanted to understand this stuff better for a while (like me!) then I have a couple of reading suggestions for you.
Simple Numbers, Straight Talk. BIG PROFITS by Greg Crabtree. This book was mentioned by Verne Harnish in his most recent work, so if you’re a fan of The Rockefeller Habits or Scaling Up then this book will probably speak to you.
I hope you’ve found something here that helps. What I personally discovered was that when I chose a new way to look at some numbers it made me see others in a new light. Big businesses have thousands and thousands (if not millions) of dollars to throw at Enterprise dashboard software and proprietary integrations with their software so they can monitor all of these things. We don’t. We have to fight to keep an eye on everything we do. I hope this helps your fight.
What are the interesting “Key Performance Indicators” you’ve developed in your business? Share some ideas in the comments!!