To know if profits are leaking from your business, and if the leaks are serious, you must measure what is happening in your business.

After all you should be running your business on facts and data, not emotion and gut feel. 

I'll get to what to measure in a minute.  First let's look at some comments people have made about measuring in business.

Some time ago I came across 5 interesting comments (or principles) relating to the measurement of how businesses provide service.  They came from a variety of sources but collectively are useful.  I have added some comments.

1.       Use data to measure, monitor and control - not to blame.  Remember Dr. Deming, "Wherever there is fear, there will be wrong figures."

2.       Price's Dictum - No inspection or measurement without proper recording;

         No recording without analysis;

        No analysis without action.

3.       Do not look under street lamps - it can be tempting to settle for the data that is easy to get.    Certainly this data can be illuminating, but it will probably not be complete, and may not address the issues you face.  This is sometimes expressed as "Avoid using research as drunks use lamp posts - for support rather than illumination"

Always start by asking the questions: "What do I need to know?", and "How am I going to use that data when I get it?"  Then search for the data which will answer the first question.

4.       Seek to use predictive measures - wherever possible move to the collection of in-process measures that will enable you to predict performance.

5.       Align measurement with intent and values - Ensure the measurement of processes and the business are aligned with their intent and values.

Walk into any well-run business and the chances are that you will see their Performance Measures somewhere on full display.  Why do they do that?  What is the benefit?

If you are not convinced here are six benefits from measuring performance::

1.       Measurement establishes the current position. Any initiatives can be measured against that and progress or lack of progress becomes easy to identify.

2.       The set of measures in use communicate the direction of the business. Companies who measure market growth tend to be moving in the direction of market growth.

3.       Measures stimulate action in the most important area.  It's a well known phrase that "what get measured, gets done".  If you are going to measure your sales force on the basis of cash collected, then you will see them carrying out collection activities.

4.       Performance assessment stops being an opinion thing and becomes a fact thing.  Discussions founded on facts are more objective and more productive.  Deming, considered the grandfather of the total quality management movement, had an expression, "Without data, everyone is an expert". Opinions can be discussed or argued.  It's much harder to argue against the facts.

5.       A good company learns from its experiences.  Measures provide feedback that enable a business evaluate the success or failure of its initiative.  It can plan to do more of what works and less of what doesn't.

6.       Measures influence behaviour of the workforces.  By identifying what is important to the stakeholders in the business the employees are given clear direction on what where their efforts should be spent.

Why do so many firms burden themselves with unprofitable projects and difficult clients?  Often, it is a question of information.  Most people have strong suspicions about where the problems lie, but can't prove it.  Measurement is a key management tool and repays the efforts invested in the design and creation of a measurement system.

In short, information enables action.

So what might you measure?

Well, you should know how your business is travelling financially.  Is it leaking profits, and if so, from where?  Financial measures can tell you about profitability, the efficiency with which you are using your money, and give an indication of risk.  They are usually looked at a ratios, sometimes expressed in percentage terms.  Here is such a list:

Profitability - Return on Assets (%), Return on Shareholders Funds (%), Return on Capital (%), Gross Profit Margin (%), Nett Profit Margin (%)

Efficiency - Collection Period (days), Payment Period (days), Inventory Turnover, Assets to Sales(%)

Short Term Risk - Current Ratio, Liquid Ratio, Stock to Working Capital (%), Current Liabilities to Net Worth (%), Current Liabilities to Inventory

Long Term Risk - Debt to Equity, Fixed Assets to Net Worth (%), Deferred Liabilities to Working Capital (%),

As well as measurements directly arising from your financial statements you might also want to derive other useful figures such as value added per employee, or average sale value.  

But measurements are not just financial, they can be operational or employee related.  If you break down the process by which you add value for your customers, each step in the process is capable of being measured.  Three such non-financial measures are the % of on time deliveries by suppliers to you, the % of on time deliveries when promised to your customers, or the time a process takes to be complete.

One thing to remember about financial measurements is that they are lag indicators.  They tell you about where you have been, not where you are going.  However by looking at the trends of these ratios you can get an idea of what is likely to lie ahead.

There are measurements that do give you some idea of what is coming up, and they are called, obviously enough, lead indicators.  Two such indicators of your future cash position are the number of sales enquiries you are receiving, and the success rate of converting those enquiries into sales.  Again the trends in these measurements give a better indication of what is happening than just an individual measurement.

I'll deal with what to measure in more detail in a later article.

In the meantime look at what decisions you make regularly in your business, and what facts and data you are using to make those decisions.

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© Adam Gordon, Profits Leak Detective