A business functions like a complex machine, requiring leadership to drive growth by pulling the right levers. With enough fuel (leading indicators) and the right mechanics (management reporting), a business machine can function more successfully and allow you to foresee challenges, adjust to almost any conditions, overcome adversity and, ultimately, thrive.
The engine of every business is located in the back office. It is fueled by numbers and built with steady cash flow. Understanding what these numbers mean and knowing how to use them to pull the right levers in the machine of your business is driven by management accounting, which reveals how to drive growth, increase profits and improve cash flow in your business.
Informed Business Leadership: 5 Ways Smart Data Drives Growth
Reviewing a balanced scorecard in your company lets you look at your financials from various perspectives (marketing, customer acquisition, client profitability and employee productivity). Management accounting gives you the accurate information you need, so you can make better decisions about operations and do a better job at strategic planning. It helps you to anticipate challenges and prepare for them before they occur, maximize process efficiency, increase profits and capitalize on your company's financial resources.
Here are 5 ways to use your numbers to help you drive growth:
1. Understand the Importance of Pricing
One of the biggest decisions affecting growth and profitability in business, is pricing. Accurately calculating the total cost to deliver your services will help you to determine your pricing. Oftentimes, what’s missing is lost value that you gave away or time leakage that people spent on jobs and it was not part of the original scope of services, so it may not actually be included in your bid. To understand the total costs, you need to look at your profitability by client or customer, by product or service, and by project.
Understand the Impact of Price on Profits
To improve your pricing strategy, you should also have a clear understanding of the impact that a discount has on your pricing. For example, if you have a fifty percent gross profit margin, and you offered a ten percent discount, you have to sell twenty-five percent more work to get the exact same profits.
Does this sound familiar - You have hesitation from a prospect, so you think, “They don’t seem to understand our value. It would be a good incentive to offer a ten percent discount. Even at ten percent we're still going to make money, its just math, right?”
Here’s what really happens - If you have a fifty percent margin, and let's say you're a million dollar business, that means you have a five-hundred thousand dollar gross profit. If you give a ten percent discount, you just dropped your gross profit from five to four hundred thousand. Twenty five percent is lost.
Here’s the flip side - If you add ten percent to your pricing, even if you sell twenty-five percent less, you get to the same profit margin. You can easily see the impact of pricing on your profitability. Because it’s at the top of the profit and loss statement, whatever you do to that top level revenue, one hundred percent of it flows right to the bottom line. These percentages grow even more when you start looking at net income.
2. Identify the End or New Beginning of a Client Relationship
You can create more profits by subtraction. If you replace your least profitable clients with higher margin business, the increased margin goes right to the bottom line.
You start the process by ranking your clients by profitability using job costing metrics – Look at the bottom 15%, and offer three options for moving forward:
- Adjust their pricing to reflect the value you offer
- Lower their scope of services to reflect the original agreement and price
- Transition them out to a new provider to fit for their needs/budget
You have to figure out if you want to renegotiate prices, deliver less or end the relationship with these less profitable clients. This will either bring their profitability up to your current standard, or move time spent for their needs onto the needs of more profitable ventures.
A lot of businesses struggle because they fear the impact on cash flow from firing a client. In fact, the opposite is true – cash flow problems are often created because businesses continue to service low margin clients. This typically happens when business owners or CEOs confuse revenue for profit. I've asked many small business CEOs who their best clients are and most answer with their larger clients, when in reality the best clients are actually the ones who “contribute” the most to profitability.
3. Know How and When to Spend Money to Make Money
You have to spend money to make money. Investments might include product development, expansion or marketing. Management accounting can help you determine which dollars spent will generate the greatest return on investment.
For example, if you can track the lead source of each client, you can look at previous marketing strategies to determine which campaigns, media or sponsorships drove the greatest returns. Each decision the company makes in marketing, sponsorship and sales can be tracked if you add “Lead Source” as a drop down on the customer record. You can add custom fields and use job costing to determine which industries, clients and product types are most profitable for your business to identify the types of ads, media and markets which will generate the best returns.
To figure out how much you can spend on marketing: first you determine the lifetime value of a client, then, determine the customer acquisition costs and finally, compare the two, to figure out how much your company can afford to acquire a new client.
When you decide to invest in marketing, you must also track your customer acquisition costs, customer lifetime value and customer break-even point. Measuring these metrics will ensure you never spend more to acquire a new customer than you will make over that customer's lifetime value.
For example, if your customers are one-time users (you teach fishing, instead of selling fish), then you either need to spend less to acquire your customers or increase revenue from a single transaction to raise the break-even point. If you have repeat customers (you sell fish, instead of angling lessons), your customer will continue visiting your fish market for life. This raises your break-even point, allowing you to spend more on acquisition costs of long-term customers.
4. Calculate Profitability by Sales Representative to Select the Best Trainers
Study the sales techniques of top performers to replicate how they sell value while not discounting the prices. When selecting employees to train new staff, you can use metrics to evaluate your sales representatives by revenue.
Selecting the best employees to onboard incoming staff will ensure your new representatives learn the best methods and most efficient tools.
It's not which employee sells the most, but which sales representative sells the most margin. You should use activity-based job costing and time-driven activity-based costing to reveal the employees who use time most efficiently and those who best generate profitability.
5. Decide When to Onboard New Staff
Hiring new employees at the right time is tricky; it takes time to find the right person and training requires even more time.
Managers should not hire as a reaction because this often leads to selecting the wrong person. Smart managers making data-driven management decisions and hire in preparation.
In addition to considering cash flow and ability to cover the cost of new hires, using metrics, a business owner can look at the average time it takes to find the right person for a job, required training time and rates of customer acquisition or growth to determine when to hire.
The ABCs of Cost Analysis: Job Costing, Activity-Based Costing and Time-Driven Activity-Based Costing
When it comes to running a business, the most important piece of information to have is how much everything costs. Although determining costs seems like a simple reconciliation of accounts, the actual process, math and concepts necessary to truly reveal how much you spend and what you spend it on are more complex.
The key performance indicators (KPIs) necessary to understand your company's true costs can be derived from three different accounting methods: 1) Job Costing, 2) Activity-Based Job Costing and 3) Time-Driven Activity-Based Job Costing. To understand where your company's money really goes, you need to understand these costing methods.
1) Job Costing
Job costing looks at the cost of individual projects or jobs compared to the revenue generated by those individual projects. Using these metrics, a company can determine which types of jobs are more profitable. For example, a food service company might consider the cost and revenue associated with renting out a section of a restaurant to a private party compared to that of seating customers and turning individual tables as usual. Or a construction company might contrast the costs and revenue associated with building a mansion to building a small home.
2) Activity-Based Costing (ABC)
Simply put, the ABC method of costing determines all of the expenses which go into delivering a product or service (not just manufacturing expenses or the cost of goods). These expenses are then allocated to the produced products or services. Activity-based costing provides more accurate and revealing information about the money truly spent on production. As most business owners know, providing a product or service is much more expensive than simply acquiring the materials or supplies.
3) Time-Driven Activity-Based Costing (TDABC)
Similar to ABC, TDABC uses a total cost of the unit, process or job being evaluated. TDABC, however, expresses cost per duration of time spent on a particular activity. TDABC calculations, for example, allow you to calculate how much your company spends per minute of mailing invoices or per hour of stamping labels on boxes (as opposed to dollars spent per mailed invoice or per stamped box). Metrics derived from TDABC are especially important, considering the largest business expenses are usually payroll and equipment.
Companies track time in different ways – Some survey employees, some use specially designed time clocks, and others base these numbers on an estimate called the practical capacity (the number of hours which one can reasonably expect an employee to operate within working hours – usually 80% to 85% of total work hours).
These are only a few of the ways management accounting will help you grow your business; the benefits from understanding your company's financial metrics and key performance indicators truly abound. You can use time-driven activity-based costing, job costing and activity-based costing to make the most of every square inch, biological cell and millisecond of your company's space, staff and time. From structuring fees, evaluating operations and excess capacity losses to identifying your most profitable products and customers, high-level management accounting will help you take your business to the next level.