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7th July 2011

How to measure small business performance

When I am asked about measuring small business performance, my first inclination is to quote Lewis Carroll. In Alice’s Adventures in Wonderland,Alice comes to a fork in the road and asks:

 

“Would you tell me, please, which way I ought to go from here?”

“That depends a good deal on where you want to get to,” said the Cat.

“I don’t much care where–” said Alice.

“Then it doesn’t matter which way you go,” said the Cat.


In other words, if you do not have a plan for where you want your business to get to, performance measurement does not matter much!


Management dashboard


Small businesses come in various guises and hence it is difficult to generalise when it comes to individual performance management. Metrics (also called Key Performance Indicators or KPI’s) can range from Software as a Service (SaaS) businesses focusing on Lifetime Value (LTV) and churn rates, to hotels measuring occupancy levels and average room yields. However the old adage holds, ‘What gets measured gets managed’, so it is important to have some metrics in place. A good starting point would be to try and understand what are the typical metrics that define success in your particular industry. After that, it’s a case of adding some additional metrics to the mix to ensure that all bases are covered.


The following represent a list of some of the more common elements that can make up a “management dashboard” which combine to help you manage performance. Of course, some may argue that profitability should be the main bellwether as to the performance of a small business. While there is merit in this view, it is better to use a combination of metrics which all support the primary goal of trading profitably while growing year on year. This way you have early warning systems in place, as an assessment of profitability based on financial statements can take some time given the reporting time lag.


It all starts with a plan


Creating a simple business plan is vital for all small businesses regardless of whether the business is looking to raise money or not. Planning is essentially about having the foresight to plot and manage your own future, in stark contrast to reacting to accounting data with its emphasis on past performance. While business plans have many purposes, they are not often associated with performance measurement, despite the fact they are a very useful tool with which to measure performance.  By committing your thoughts to a business plan you can ensure that you (or your team) know what the priorities are, what activities need to be done, who needs to do them and by when. A business plan brings a lot of transparency to the business with accountability in the form of names, actions and dates.


Cash-flow management


Careful management of cash flow is a fundamental requirement for all businesses. The reason is quite simple–many businesses fail, not because they are unprofitable, but because they ultimately become insolvent (i.e., are unable to pay their debts as they fall due).
If you are a “cash-only” business, you can bank the income immediately. However, if you sell on credit, you receive the cash in the future and hence may need to pay some of your own expenses before that income hits your account. This will put a further strain on the company’s solvency and hence a well structured business plan will help you manage funding requirements in advance.


Pro forma profit and loss


A profit and loss forecast is an integral element of any business plan alongside a pro forma sales forecast and cash flow forecast. These statements are forecast in advance (broken down by month) and represent a reference point for actual data as it emerges.  By forcing you to forecast and to document all expected revenues and costs, the process helps you produce a report detailing the likely trading performance for the year ahead. If you are an established small business, this data is easier to arrive at as you can use past performance data as a reference point. While brand new businesses’ lack of trading history makes this process more difficult, it also makes it more valuable - you need some references to know whether your new business is on track.
Once you commence trading and have actual real data, it is then easy to undertake some variance analysis (between the forecast data and the actual data) to assess whether or not you and your business are on track. With actual data it is possible to take remedial action before waiting for a full year of historic transactions to emerge, at which point it may be too late. For example, if sales in month one are significantly below the planned level you can make an early decision regarding what actions need to be taken as a matter of urgency (i.e. perhaps bringing costs into line, increasing marketing activities, pivoting the business, etc.)


Google Analytics


If you are running a website it is essential that you are running an analytics package in the background (Google Analytics is one of the more popular free ones). This enables you to gain a real insight into customer behaviour on your website. If you are an ecommerce site, you’ll be able to analyse details like the eCommerce Conversion Rate (ECR) and aim to improve this rate over time. Given that your revenue is essentially a factor of two elements (ECR * Number of visitors), improvements in these two will help you drive business performance improvements.
 

Peer analysis (ratios)


You can also assess your business performance by measuring some key financial ratios and benchmarking these against results from peers (which are typically aggregated to ensure anonymity).
This data is typically compared according to industry codes as determined by the  North American Industry Classification System(NAICS) and its predecessor Standard Industrial Classification(SIC). This system helps facilitate peer analysis as companies are grouped according to industry sector. While these systems were well suited to analyzing relatively homogeneous industry groups in the 1930s, I do not believe they are well suited to modern organisations with multiple revenue streams, and disparate business models. However, some small businesses with straightforward, conventional business models may find such data comparisons useful.
In summary, measuring performance is an important element for all entrepreneurs and small businesses. However, given the huge breadth of products and services provided, it is difficult to assign blanket metrics. The above will give you some ideas as to the sorts of things to be thinking about and these can be added alongside key performance indicators specific to your industry sector. Once set up it is easy then to keep an eye on these to ensure that your business remains on course.

Alan Gleeson is the Managing Director of Palo Alto Software, creators of Business Plan Pro®. He holds an MBA from Oxford University and is a graduate of University College, Cork.

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