When it comes to managing any type of business and making business decisions — nonprofit, for-profit, service, commodity, or something else — leaders have two ways to do it:
- by making gut-based decisions; or 2. with data-driven decisions.
While it's possible for business owners to get lucky, making decisions based on instinct and providing exceptional sales, service, and products, others aren't so fortunate. The only way to run a business confidently, while achieving enduring success and growth, is by making data-driven decisions facilitated through management accounting.
Regarding management accounting and KPIs, GrowthForce's President and CEO Stephen King recently spoke with Robin Stanaland, experienced Executive Consultant, Business Coach, and Master Chair of Houston’s regional Vistage group. A six-time star winner, Stanaland lands in the top 3% of Vistage's 700 chairs worldwide. She has coached countless business owners, non-profit directors, entrepreneurs, and seasoned CEOs of businesses ranging in size from millions to billions to maximize their revenue, valuation, and success.
"Regardless of the size of the company, from the billion dollar guy to the two million dollar guy," Stanaland noted that businesses repeatedly struggle with the same problems. "One, being people, of course. Everybody is going to have people issues. But the other is really understanding their data and managing their businesses from the numbers. It's surprising, to me, how many CEOs don't do that."
How to Use KPIs to Make Better Decisions for Your Business
Basing business management, strategies, goals, and decisions on financial data solves countless problems faced in business, including the people problems which Stanaland referenced.
Diligently recording data, measuring and tracking key performance indicators, and learning to apply historical financial data to your everyday business operations and strategic planning, will help you make the right decisions. These data-driven decisions will maximize your company's revenue, minimize your costs, grow profit margins, and accelerate success.
Optimize Pricing to Maximize Profits, Not Just Revenue
Business owners often focus on maximizing revenue, rather than maximizing profits. The problem with this strategy is that, depending on profit margins, greater revenue doesn't always equal greater profits.
If your business generates lots of revenue, but still finds itself encountering cash flow shortages, then you likely have a pricing issue. According to King, "Most business owners don't understand that if [they have] cash flow problems, it's . . . because of pricing."
For example, a business, owned and operated by a husband and wife team who are also members of Vistage, hadn't been making money — even after cutting costs, investing in sales and marketing, and diversifying their product lines. After reviewing their financials, they raised their prices at King's recommendation to do so. Shortly after increasing their prices, a new competitor arrived in their market, offering similar services for much lower prices. The owners observed their competition doing more business than they were. The competition's service trucks were consistently dispatched, while the member's trucks sat idle.
According to Stanaland, "He walked in . . . red-faced and . . . ready to show us that we were wrong." The business owners were both upset and nervous they had received what seemed like bad advice from the group.
The owners, however, hadn't been watching their key performance indicators. After comparing the company's current and prior years' profit and loss statements, it was clear that — in spite of lost clients and lower revenue — their net profits were way up. Compared to a loss during the previous year, charging the previous prices, the business had already generated roughly $200,000 in profits in just six months by servicing fewer clients and charging optimized prices.
Establishing good pricing is more complicated than it seems.
Owners must consider all of their costs associated with different job types before they can optimize their prices and pricing structure. With a variety of pricing methods, levels, and types of clients, many businesses do not request the right amount in exchange for their products and services, which can result in money lost on certain types of transactions. In these cases, business owners find themselves coming up short when it comes time to cover their expenses. If every sale or client generates a positive net profit, then your business's perfect pricing should leave you with money in the bank, like it did the business owners from our story.
Manage Margins to Secure Profitability
Profit margins reveal your true profits, rather than total revenue, which is essential to measuring your success. Track both your business's gross profit margin (revenue minus cost of goods sold) and contribution margin (revenue minus variable costs) to gain a clear understanding of your profits and also your break-even point.
Evaluate Revenue Streams with Individualized Profit and Loss Statements
Stanaland has observed that her clients often have one customer who generates most of their revenue. As a result, they assume that's the best client. She said, "A lot of times, it's a big company . . . They usually have the lowest margins, and they are generally taking up most of your energy." She described how her clients dedicate massive amounts of resources to servicing these types of clients. "But," she said, "there are ways to tell when it's not really a good client."
Happy to discuss this all-too-common problem, King pointed out a recent example of an IT company servicing Apple. "They were really proud of Apple," he said. "Naturally, you think that your biggest account is your best."
GrowthForce set the company up with automatic labor and cost allocation systems to perform accurate job costing. After running profitability reports by customer, King said, "The Apple account was barely breaking even." Wanting to provide the best service possible to a high-profile client, the company had been dedicating its most experienced (highest paid) employees and most expensive resources to the account.
Low margin clients, even high-profile ones, cause cash flow problems. After firing Apple as their client, this particular IT company enjoyed skyrocketing profits the following year. As Stanaland pointed out, "without management accounting and reporting, they wouldn't have known it."
Unit economics and job costing reveal the most and least successful revenue channels. From individual employees and entire departments to separate product lines, services, jobs, and clients, KPIs can reveal which ones generate the greatest profits and which might be costing you money.
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