By: Larry Fish, President
Take it from me, I know the value of understanding the numbers side of our business. Sales, profit, pricing, budget to actual, projections, re-forecasting, plus the myriad of other transactions that take place in a business make it difficult to stay on top of important trends. I am not an accountant by training, but as a business owner, I feel that’s a pretty feeble excuse for not knowing the key drivers of your operation and the resulting financial trends.
One of the ways to monitor your business without having to look deeply into the financial details is to identify some key ratios that, if properly monitored, can give you a “heads up” on both positive and negative trends, especially regarding customer and people costs. Let’s take a look at a few that might make sense for your business.
Revenue to Expense
An old Controller turned CEO once told me, the ideal relationship between revenues and expenses is that revenues should grow at twice the rate of expenses. Obviously this is hard to do, but it does create a ratio that helps identify how much in revenue your company generates for every dollar of expense it incurs. Many very solid companies operate at a $1.50 to $1.65 revenue to expense ratio. How’s yours?
Revenue to expense ratio = total revenues divided by total expenses
Here are some others – – –
Return on Space
Companies that are constantly trying to determine the most productive use of square footage and real estate might find this ratio an interesting one to watch:
Return on Space = net profit after taxes divided by floor space
Revenue to Space
Conversely, operations that are largely retail driven operations may be interested in this ratio, since it will give them a good look at how efficient their use of available floor space is in terms of generating revenue. It might also come in handy when evaluating what revenue needs to be generated when leasing very expensive floor space. This ratio only measures dollar sales per square foot and does not look directly at the cost of space.
Revenue to Space = net sales divided by floor space
Expense growth from one year to another can be an elusive trend if you don’t have an easy way to check it. When looking at this one, it’s a good idea to look at it alongside growth in net sales as well.
Expense Growth = total expenses minus expenses last year divided by total expenses last year
Real growth from one year to another can sometimes be determined by the growth in new customer counts. This is by no means an absolute indicator of growth but may be another key indicator worth tracking. This ratio tends to indicate a fundamental growth that is not affected by market changes or economic factors.
Customer Growth = 100 x customers this year minus customers last year divided by customers last year
Employee Turnover is another good ratio to track. It should never be looked at in a vacuum, but should be tracked in concert with other important ratios that are indicators of the health of the business. Far beyond the impact turnover has on employees who actually leave a company, it is also an important indicator of management’s effectiveness in dealing with an increasingly scarce resource, its people.
Employee turnover = 100 x employee terminations divided by average number of employees employed during the year
Now, don’t go out and fire your accountant, bookkeeper or CPA after reading this article. Ratios are meaningless unless they are compared to something and tracked on a regular basis. Another trap with ratios occurs when we start to track so many of them that the process implodes from over-analysis and under-use.
All of us have certain blind spots and weaknesses when it comes to understanding and using good financial information. Determine what your blind spot is and then see if there is a ratio that, if identified and tracked on a regular basis, can give you a set of good questions you should be asking of those who do your books. Look at combining and tracking certain key ratios that might have cause and effect relationships. You’ll be surprised what you will uncover.
Disclaimer: This article nor any portion of its content may be reproduced without the expressed written consent of GreenSearch®