Rose Report: Issue 11

Staying Ahead of the Curve

Assessing key performance indicators (KPI) and financial reports—including the balance sheet, income statement, and cash-flow statements—on at least a monthly basis is a fundamental part of proactively managing every business. “This provides organizations with the clarity to understand their financial position and make sound business decisions,” explains Tim McGarrity, Senior Controller at Rose Financial Services.

Analyzing the trends over the previous 12 months is one way companies can determine what the future likely holds. Organizations must realistically manage their business, including periods of growth, to ensure expense growth and cash demands are not outpacing the growth in revenue and available cash. Perhaps more critical is the need to take proactive measures to deal with a declining business environment. In a declining revenue scenario, any hesitation to take action can result in cash flow problems and even failure of the company.

In reviewing the balance sheets an important KPI is the ratio of current assets to current liabilities. A ratio below 1.25 signals to an organization that it needs to proactively forecast and manage cash to ensure it can meet its short term obligations. Days Sales Outstanding (DSO), the average days it takes a company’s customers to pay invoices, is also a KPI. If this number is high, it indicates either a problem with revenue recognition, cash collection, or both, and immediate action should be taken to resolve the problem. Most business people understand that an aging receivable only becomes harder to collect.

Income statements allow organizations to understand trends in revenue, such as the cyclicality and seasonality of income. They are can be loaded with KPIs, including revenue concentration by product and/or client, direct versus indirect costs, fixed versus variable expenses, and net income as a percentage of revenue. For service-oriented businesses, revenue per professional is a KPI. Another KPI to monitor is gross margin or gross profit expressed as a percentage of revenue. RFS’ McGarrity notes that organizations should watch for any significant fluctuations in gross margin percentage from one month to the next. Such changes could indicate that an organization is not correctly matching revenue with expenses. Also, a downward trend in the percentage is an indication that the company is not properly managing the direct costs in relation to revenue.

The bottom line: Establishing, monitoring, and analyzing monthly KPIs is a critical aspect of the financial reporting process for every business. Business leaders who use financial statement KPIs to proactively manage their organizations have a competitive advantage in the marketplace, and much greater control over their future success.