Business Financial Statements... Yawn. Key Performance Indicators... Wake Up!
Financial statements can be boring. Yes I, the accountant, admit that financial statements are boring.
And financial statements can be worth less than the paper on which they are printed if you don’t understand what you are reading or if they are inaccurate. But, financial statements are a necessity. We use them for many reasons: as the basis for income tax return preparation, bank loans and buying a business to name a few.
But financial statements are wholly inadequate as the sole basis for making decisions to run a business. If you want to run your business better, read on. (And, if you want to be able to read a financial statement meaningfully, call us.)
Financial statement formats were developed to offer consistency from year to year based mostly upon the intended users' needs. These intended users were primarily banks and trade creditors. Bankers and trade creditors needed businesses to show: 1) security for their loan (assets and collateral), and 2) an ability to repay the loan (profitability and cash flow to service the loan).
The two most widespread financial statements are balance sheets and income statements. Balance sheets show security: assets, liabilities and equity of the business at a point in time in the past – like a snap shot on Friday of last week, 31st of last month, or December 31st of last year. The income statement shows repayment ability: income and expenses for a period of time in the past: last month, last quarter, last year.
My point here is that financial statements are of the past. Last month, last quarter, last year. And while that information can be beneficial, and we strongly encourage monthly reporting, it is simply not enough for you to run a business.
Developed over decades, scholarly-type CPAs in starched shirts and dark suits promulgated what financial statements for businesses would look like. Are we really stuck with this? Is this all that is available to help me run my business?
Could you safely drive your car without the instrument measurements shown on your dashboard? No, you could not drive a car or fly an airplane today without speed, direction, fuel, or other indicators from your trip last week or last month. You need real-time information. Trailing indicators, like financial statements, simply are not as valuable as leading indicators. And in the same manner, running a business with just a financial statement is not safe either.
So, what is one to do?
Every business has 6 to 12 key activities which, when measured, will give a very good indication of the direction of the business. We call these measures Key Performance Indicators or KPIs for short. Answer this question: what are the 6 to 12 things you must absolutely, positively get right about my business for it to work? Next, how do you measure each of these? And for each of these things you must get right, what is a metric or measure, preferably a leading indicator, of performance? We will speak more about Critical Success Factors in a later post, but for now, try to identify your critical success factors and a measure for each.
Here is an example. An indoor private partty franchise for children's birthdays and other special occasions. Separate zones with inflated party structures were available for appointments for a block of time each day. A KPI that was critical to their success was the number of parties booked. So, if looking into the future 4 weeks out, the business typically had 40 parties booked, they knew something needed to be done if that number suddenly dropped to 20. Since the party bookings KPI was a leading indicator, they had time to respond: get on the phone, place ads in local media, run a special, etc. A financial statement simply would not replace the information in this one KPI of booked parties.
Now imagine that you have 6 to 12 of these KPIs to help you run our business. KPIs are powerful. KPIs are liberating. KPIs are actionable.
For our accounting firm, we actually track 20 KPIs.
Now imagine that you have developed these 6 to 12 KPIs, and that they are presented to you in a business dashboard, much like that of the dashboard of your car. Pretty cool stuff.
Think you could run your business better? More profitably? Better information to respond to change? Yea. Me too. Financial statements just don't do it.
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