Know your KPI

Feel Shame Because You Don’t Know Your Finances? Doesn’t Have to be That Way.

Entrepreneurs feel shame around not knowing their finances. It doesn’t have to be that way. Know your KPI’s, and you’ll know your business.

My friend and I were hanging out and we started talking about business. He was wanting my thoughts on whether he should expand. As an accountant, my next question naturally was, what are your Gross Margins? He tried his best, explaining the costs that go into providing that service, but he couldn’t give me a %. At that point, he became quite embarrassed.

I didn’t realize until that moment, but I’m sure lots of my clients feel that way. They got into business to do something they love, and bookkeeping is just something that they have to do. Even when it’s done, they may not know what to do with their numbers.

If you are feeling this way, just know that you’re not alone. Here are a few good places to start.

Gross Margin

Gross Margin is Revenues minus Cost of Goods Sold.

Why is this important?

It tells you how much they have left over from sales to cover other operating expenses. You have to make sure you Gross Margins are high enough to cover your operating expenses.

For example, you’re a consulting company. Your revenues are your invoices to your clients. Your costs are payroll to your sub-contractors or your employees to provide those consultations. Or, you are a restaurant. Your revenues are your sales, and your direct costs to provide those meals are food costs and labour. Let’s say your revenues are $100,000 for the month, but your costs to provide that product/service is $75,000, then your gross margin is $25,000, or 25%. This means that for every dollar you bring in, you only have $0.25 to go cover your overhead, which includes rent, management wages etc.

If you’re not getting this information, make sure to ask your bookkeeper to structure your bookkeeping so that you can get his figure on a monthly basis.

If your gross margins are low, consider the following

  • Can you improve your operational efficiency to lower cost?
  • Can you raise prices?
How to increase your Gross Margin: Improve your Operational Efficiency to Lower Cost and/or Raise… Click To Tweet

Comparisons vs your prior year or quarter

Tell your bookkeeper to send you a “Profit & Loss statement separated by month, with comparisons against prior year or prior quarter”. You can literally copy and paste this request. (If they don’t know how to get this information to you, it’s time for you to get a new bookkeeper).

Why is this important?

This report will show how you’ve done with a comparison to the same time period last year or last quarter. It provides very valuable information because it can show you how you have grown over the past period, but also where your expenses went up.

For example, if you’re doing $60K in January 2017, and you did $30K in January 2016, then the good news is that your business has doubled in one year! However, if your wages increased from $15K last January to $40K this January, then that’s not a good thing. Comparing your financials to other periods gives you context.

Rent

If you are a business that has a high rental cost, such as manufacturing, retail, restaurants, etc. it might be good to consider these 2 financial metrics

Rental efficiency ratio

Basically you take revenues and divide by your rent. E.g. $100K in revenues and you pay $10K in rent, then your rental efficiency ratio is 10:1.

Why is this important?

What this means is that for every $ you pay in rent, you get $10 in sales. This means very little in a vacuum, so it’s important to track this metric from month to month to see if this ratio is increasing or decreasing. Consider how you can increase this ratio. How can you increase sales without having to increase rent?

$ / sq foot

Similar to the ratio above you take the revenues and divided by the sq foot of your store. E.e. $100K in revenues in a 1000 sq foot store. Then you’re generating $100/sq foot.

Why is this important?

Again, it doesn’t mean anything on its own, but if you compare it to your competitors or track it from month to month, you can see if you are able to increase your sales without increasing your store footprint. Often times, this can be done by adding complimentary products that don’t that much more space. For example, a gym can start selling towels, t-shirts, books or drinks. A restaurant can sell art, or dessert-to-go. You can increase revenues without taking up that much more space.

Labour efficiency ratio

If you have a business that heavily depends on labour, then tracking this ratio is essential.

Why is this important?

It tells you how much revenues you bring in for every dollar you spend on labour. For example, if you have $500K in revenues, and you’re spending $300K on labour, then your ratio is 5/3 or $1.7. For service based businesses, you should be aiming for ~2. Keep track of this ratio and see how you can improve it on a monthly basis.

Job costing or division tracking

Like most businesses, there are lots of moving parts. For a trades and construction business, you might have many jobs all going on at the same time. Therefore, it’s extremely important to ensure that all of your jobs are profitable. Quickbooks allows you to do job costing for each of your jobs. Have your bookkeeper explore ways in which they can demonstrate to you how much profit you have made from each job after materials and labour.

You might have divisions. For example, we have a client who is part Retail business, part event equipment rental. They are two unrelated businesses operating under the same umbrella. Therefore, we created 3 divisions – Event rental, Retail Store, Head Office – so she has absolute clarity on which division is profitable and which is not

For us, Legacy Advantage has 2 locations and 1 “phantom location”. We have an office in Vancouver, an office in the Fraser Valley, and a “Head Office”. We allocate all revenues and costs associated with these locations accordingly. Then I allocated Head Office expenses to each location accordingly. For example, marketing costs and my wages are split a third, a third. This type of allocation gives me extremely valuable financial intelligence so that I can make better decisions.

In Summary,

Don’t just look at the net profit number. Know your KPI’s. You’d be missing out on so much by not digging into the details. Have your bookkeeper report on these ratios above and gain more financial insight into your business.

 

About Bob Wang

Bob is the owner and founder of Legacy Advantage. He holds a CPA and has experience at a private client services brand, Big 4. Bob's passionate about empowering organizations through quality bookkeeping services.
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