“But in my opinion, all things in nature occur mathematically.” ― René Descartes
When I am assessing a business or leader of that business, I listen carefully during the first few minutes of the conversation for the sign of a number, any number! If I hear it, I draw a sigh of relief, knowing that I am talking to someone who is serious about the business. If I don’t hear a number early on, I start to worry and ask a series of close ended questions to tease out some hope, such as: “What was your sales growth last year?”, “What are your gross margins, or any margins for that matter?”, “Can you tell me one or two key ratios?”. This line of questioning invariably separates the wheat from the chaff and the truly exceptional business owners begin to emerge.
In my experience, knowing how to describe your business numerically is one of the top, tell-tale traits of exceptional entrepreneurs, business owners, CEOs, executives and managers. Why? Because good numbers are objective, not a figment of someone’s imagination, dreams, hopes, wishes and desires. Good numbers show how the money flows through a business, which helps clarify the business systems and obstacles. Good numbers show trends which can moderate or accelerate executive actions through enlightenment. Good numbers are a common language and give common comparisons across sectors and the globe.
Here is how I recommend business owners get into the habit of developing financial numeracy skills.
Focus on a critical few, not the trivial many: Identify a small number of key financial indicators, no more than 6. This should include measures of revenue, margins, working capital and cash flow. Don’t try to boil the ocean.
Make it relevant: Pick financial measures that are relevant for your industry sector and stage of growth. This will keep you focused on what truly matters and will give you real and valuable tools to manage and grow the business.
Improve your financial literacy: If you lack a business degree from Wharton, don’t panic. Take some extra education in the form of seminars, webinars, continuing education or what ever works for you. Treat it seriously and you will learn quickly.
Add financial capability to your exceptional team: A top notch CFO, Controller or Accountant is imperative for the success of your business. Hire one and get someone good, really good! Ask them to explain everything to you in detail and make them full partners in managing the entreprise. They must keep their finger on the financial pulse of the business.
Pick good financial indicators: While these may vary by sector and stage, here are a few financial indicators that I look at and are applicable across many situations:
- Revenue (most recent period and change from previous period)
- CAGR (Compound Annual Growth Rate) for a key metric
- Gross Margin % (Revenue – COGS / Revenue)
- Acid Test Ratio (Cash+A/R+S/T Investments / Current Liabilities)
- Current Ratio (Current Assets / Current Liabilities)
- Net Profit Margin (% of Revenues remaining after operating expenses, interest and taxes)
- Cash and Working Capital Measures (i.e. A/R, A/P and Operating Cash Flow Ratio)
Additional important metrics include customer retention rates, cost of customer acquisition, customer lifetime value and a measure of productivity.
Becoming well versed in a few key metrics will give you more clarity in the operations and prospects of your business, while giving your investors, employees and partners more confidence that the business is in good hand. Take the time to learn and do it right!
Eamonn has a B. Eng. (Electrical) from Lakehead University, MBA (Finance) from University of Toronto, and has completed Executive Education at Stanford University Graduate School of Business. He lives in Vancouver, Canada. Follow him on twitter @EamonnPercy.