Recently a client sent me an email with a curious question: “What is coming that I do not see?” All leaders have asked this question one time or another. However, most fail to address the real reason they had the concern. Max (not his real name) was concerned because his financial results (while very positive) were a surprise. He was wondering if there was a better way to avoid positive and negative financial shocks. The key to avoidance is a better understanding of your financial results and the metrics that lead up to them.
There are 5 Reasons to Become Better at Understanding Your Key Metrics
1- Lack of understanding key metrics leads to poor decisions.
2- Fear causes your organization to slow down.
3- Lack of financial vision causes your organization to squander key financial resources.
4- Forecasting focuses leaders on the core issues and leads to business acceleration.
5- Lack of mastery of metrics leads to poor accountability.
Predictable Cash Flow is Achievable
The challenge Max and many other leaders face is to overcome their lack of expertise, commitment, and discipline when it comes to gaining a complete understanding of their financial statements and the underlying metrics that drive them. Unlike factors such as a COVID-type event, most financial outcomes can be predicted with a reasonable degree of accuracy. In fact, it’s likely that most of you who are reading this are not comfortable with metrics and finance in general. That discomfort should not prevent you from requiring the same high standards and rigor you demand in the other areas of your business. The good news is that every business leader can address this problem. Committing to better forecasting will make your business stronger, and you don’t have to empty your bank account to do so.
Lack of Understanding Key Metrics Leads to Poor Decisions
After working with hundreds of companies, I have noticed one difference between top industry performers and the rest. In top-performing companies, everyone knows their numbers. I recently witnessed this in action with Company X (not their real name). Company X has great products and services yet failed to make a profit. We were working with several companies in the same industry. All those other companies had accurate and timely financial statements and the right metrics to evaluate how to improve their financial results. Company X never had accurate or timely financial statements for their management meetings. Worse, management had lost trust in the numbers they did have.
Because they lacked reliable and timely information, they made decisions based on hunches. They made all the logical moves to improve a business in their industry. Unfortunately, they were not seeing or addressing the right issues and challenges. Convinced their whole problem was selling, general, and administrative expenses (commonly known as fixed overhead), the leadership team focused on cutting these expenses. While minimizing overhead is a good business practice, it did not get to the root of the problem. In some cases, cutting the expenses caused the company to be less profitable. They were cutting through the bone.
Company X’s main problems had nothing to do with fixed overhead. In actuality, their fixed costs were lower than that of competitors of similar size. After pushing for better information and competitive benchmarking, they realized their gross margin (revenue minus direct variable costs) was awful. Their gross margin was operating 50% below the better players in the market. It meant that the leaders running their operating departments were failing to perform, and these leaders were hiding in plain sight. In the end, it was determined that they had a pricing problem and direct labor costs required to deliver their services could and should be much lower. Before having this knowledge, they failed to focus on addressing those two issues.
These challenges are predictable and solvable.
Fear Causes Your Organization to Slow Down.
It seems obvious that fear can cause your organization to slow down, but what are you doing about it? Imagine you are in a long dark cavern with many possible turns, no flashlight, and no directions. How fast will you move through that cavern to get to the other side? Most people would slow down and be more cautious. Those who want to try to move quickly are likely to trip, hit their heads, get lost, and possibly injure themselves in the process. Some people may reverse course because they find it too dangerous to move forward or don’t want to go through the trouble.
Now imagine facing the same cavern, except now you have a high-powered flashlight, night vision goggles, and a map showing you the quickest way to the other side. Most of you run your businesses more like the first scenario than the second. And it costs you significantly.
Using the right metrics allows everyone in the organization to contribute to your success. Learning and using your company’s metrics will enable you to show each employee the way to peak performance. The more people that have this flashlight, the better and more predictable your financial results become.
This challenge is predictable and solvable!
Lack of Financial Vision Causes Your Organization to Squander Key Financial Resources.
Getting ahead of oneself is something I wish I could tell you I have never done. I am guilty of bringing on too many people too quickly. Also, I am guilty of investing too heavily in a new endeavor without testing it. We have all done it. I can tell you in almost every single circumstance I should have known better. I was making decisions that defied reality.
A great example is a business services company. They had national growth aspirations, great products and service, a strong reputation in their local market, and the CEO was highly driven. The company was highly profitable, but its growth had stalled in its local market. Rather than addressing the fact that their existing sales team was failing to perform, they doubled the number of sales team members and tripled the number of markets. The result was predictable. Almost all the new salespeople failed. The company got little traction in the new markets, and the old salespeople continued to perform poorly.
You might be thinking, this is an easy problem to solve: Hire the right sales manager, fire the team, and build a new one. That is what most companies would do. However, this company’s data was telling them a story that they did not want to recognize. They had the highest customer churn in years; the owner, who had been a star salesperson in the industry for over 30 years, was no longer producing; and getting meetings with new prospects seemed to take an act of God. After challenging their performance, we learned that their pricing was no longer competitive for the value delivered. Additionally, the market had shifted, and the leaders failed to recognize and address the current market’s needs. Before adding salespeople and a new sales manager, this company needed to address its strategy issues.
By not addressing the real issue, you may be following the plot of the movie 300. The story revolves around King Leonidas, who leads 300 Spartans into battle against the Persian “God-King” Xerxes and his invading army of more than 300,000 soldiers. Despite having 300 of the most formable soldiers globally, there was no way for them to win the battle. I see this same plot playing out in many companies.
This is another problem that is predictable and solvable!
Forecasting Focuses Leaders on the Core issues and Leads to Business Acceleration
Let’s get back to Max. Max leads a company that has lots of good data. They needed more discipline and focus on understanding their metrics, what issues they should be addressing, and how to recognize the leading indicators causing the surprises in their financial results.
After reviewing actual results and comparing them to the forecast, we learned many things. They had identified and used the right metrics but needed to get better and to set realistically high assumptions. In Max’s case, they beat their sales goal but how they originally derived the sales goal had no bearing on reality:
1- They had 40% fewer leads than expected. This happened because they had not done enough analysis to understand how many leads would come from each marketing channel in each market. Had they looked at the past performance, they would have known there was no basis for their targets. And, they had no new action plans that would drive different results.
2- The company exceeded its sales goal by 25%. There was no correlation between the assumptions used to develop the costs. They got the following wrong:
- They forecasted having all positions filled in their sales department despite knowing that they were beginning the month with nine open sales positions.
- They had several new salespeople who normally do not derive any sales for at least 45 days (their sales cycle).
- Their target appointments, appointment conversion rate, and sales closing ratios did not resemble anything close to reality.
Max can now work with the department leaders to improve future forecasts reflecting what they learned. Based on new assumptions, they are going to destroy their sales goals for the year.
This was predictable.
Lack of Mastery of Metrics Leads to Poor Accountability
To establish a proper accountability system, you need a clear understanding of your metrics, the same metrics required to build your forecast. Invariably, forecasts and budgets are wrong because they are built the wrong way. In most cases, leaders look at last year’s numbers and decide at a high level what they want the new numbers to be. However, the devil is in the details, and not the details most budget creators think about.
Leaders need to spend significant time understanding the leading metrics (e.g., number of units sold, number of people required to sell that number of units, number of new customers, number of returning customers, etc.). It would be best if you looked back to understand the trends and underlying causes of those trends and project forward what will happen to these leading metrics in the future based on your business plans. A good example is Max’s company. The number of performing salespeople is a crucial component to the company’s success. Fewer performers will ensure lower results. Thus, key considerations are what percentage of salespeople meet quotas and whether those quotas are reasonably high enough to justify the employee’s tenure.
You might be wondering how understanding metrics ties to accountability. Max’s sales manager believes she performed well because she beat the budget. However, the budget was a farce in that none of the company’s performance standards were met in her department. Despite exceeding the revenue budget, the number should have been higher. This conclusion arose by looking at a complete set of metrics rather than the final revenue number. A primary driver was the number of open sales positions. The lack of people caused them to fall well short of potential.
Moreover, once we started evaluating the critical success metrics (e.g., number of meetings, meeting conversions, etc.), it was clear that there was a lack of integrity in how they were derived. Not even management was confident about what they should expect. You can’t hold a person accountable without valid expectations.
The results could have been predictable, and this problem is solvable.
Practice, practice, and more practice. You can only get better at forecasting with commitment, discipline, and continuous improvement. And the Finance department is not solely accountable for forecasting. Instead, it is a process that requires input from everyone. All leaders need to help develop the metric targets related to their departments. It is also helpful to run the standards by the employees that must deliver on them. The feedback is where the gold lies.
With practice, I believe every leadership team can produce highly predictable results. Each time you go through the evolution of a new forecast, you will learn new ways to improve performance and strengthen accountability in your organization.
Howard Shore is a business growth expert who works with companies that want to maximize their growth potential by improving strategy, enhancing their knowledge, and improving motivation. To learn more about him or his firm, please visit his website at www.activategroupinc.com/contact or contact Howard Shore at (305) 722-7216.