Many businesses have a fundamental gap in the ability to measure performance. The gap is a missing connection between financial results and operations.
Managers need to know the financial impact of their decisions.
So, businesses need to inform their operational managers with the right financial data to measure their performance and improve their business. When income statements, balance sheets and cash flow statements don’t tie back to operations, they have limited value.
Managers don’t always know which customers or products are profitable. Grant Thornton Advisory Services Director Chris Ciannella recalled a company that focused on pursuing large contracts, because management believed these contracts were more profitable than smaller contracts. “With customer-level data analysis, we discovered the exact opposite was true,” Ciannella said. He cited another business that reduced its sale price to drive sale volume — yet, he found that the business lacked the necessary information to measure the sales volume needed to offset the margin impact of the price decrease.
“Operation managers need to have the right financial information to make critical business decisions, and finance managers need to measure and provide that information.”
“Operational managers need to have the right financial information to make critical business decisions, which financial managers need to measure and provide,” Ciannella said.
Ciannella summarized the most critical financial information that operational managers need in order to properly manage their business:
- Looking Back:
Standardized financial reports with variances to prior periods and budget
This is the bread-and-butter income statement that includes enough detail to provide value, but not so much detail it loses its importance. This should include sales and sales growth in terms of dollars and volumes, gross margin percentage, SG&A costs by department (manufacturing, sales, administrative, research & development, and any other meaningful, relevant industry information), EBITDA, capital expenditures and debt service. Variances to budget should be understood and explained in the context of the business — to clarify if these variances simply represent a timing difference from the original budget or a difference that will impact the year’s financial performance. Significant variances that can’t be sufficiently explained, or that consistently occur, are variances that should be investigated because they can indicate an underlying problem with the business.
- Looking Ahead:
After understanding how the business is tracking to its original budget, financial and operational managers can take an informed look ahead. They should view financial forecasting models as “living” documents during the year. Establish a regular monthly or quarterly cadence for updating the forecast and communicating the revised figures with the necessary members of management and the leadership team. Visibility into the operating performance and outlook is key to making informed decisions.
- Measuring Profitability:
Customers and products
Too many companies have an insufficient understanding of customer and product profitability. Understanding which customers and products are making the most or least money is critical to understanding and properly managing your business. This information can help a business focus on the segments that will increase its profit the most or allow management to consider the areas that aren’t as profitable, investigate why and evaluate needed changes.
- Measuring Operations:
Key Performance Indicators (KPIs)
Every monthly report should include a summary of KPIs, including historical KPIs to measure trends. KPIs vary by industry and audience, but can include sales backlog, days sales outstanding (DSO), days inventory, sales per square foot, revenue per employee, throughput, capacity utilization, units sold, average sales price, days since last accident, and the status of firm initiatives such as cap-ex. Tracking KPIs could be as simple as red, yellow and green to indicate status. Any one of these KPIs can help managers watch for improvement or decline in critical areas. This will allow management to react with timely and appropriate changes.
These reports can substantially impact management’s ability to monitor performance. To help drive business growth, leaders must reassess what reports managers are reviewing, and how often. Consider whether other KPIs should be measured and monitored, or whether someone else should be included in the distribution of information. Finally, resolve to establish and maintain clear links between financial reports and operations that can improve your business decisions, and ultimately your profitability.
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