30 Sep, 2019
Choosing the right Key Performance Indicators (KPIs) for Small-to-Medium Enterprises (SMEs) may seem overwhelming, but measuring the right metrics is an essential task for the successful business advisor.
In a recent study, Xero found that accountancy firms in Australia offering business advisory services made 35% of their total revenue from budgeting, cash flow forecasting and business planning. For firms in the United Kingdom this was slightly lower at 29%.
In the United States, 88% of businesses rated these particular business advisory services as one of the top three services that accounting firms could offer.Selecting the right KPIs to track with each of your clients is the crucial first step in providing business advisory services.
KPIs distill complex, disparate information into single metrics, providing insights at a glance and giving SMEs the best chance of reaching their business objectives. Chances are, your clients are going to need help sorting out which metrics to track, how to compile the necessary data, and how to accurately calculate KPIs.
Four key areas you should look at when considering which KPIs to select for SMEs
How accurate is your client’s source accounting data and what is the business owner's appetite for financial insights and management reporting?
If you’ve ever made decisions based on data you’d consider inaccurate, research says you’re not alone.
In 2016 KPMG released a study which showed that 10% of CEOs surveyed actively distrust their organisation’s use of data and analytics.
20% have limited trust for nearly every aspect of the way their organisation uses data and analytics, and only 33% of respondents had a high level of trust in the accuracy of their data and analytics.
This lack of trust undermines strategic decision making and can cause organisations to react based on gut feel, instead of using data driven insights. This can lead to suboptimal outcomes, and ultimately cost the business money and time.
It’s important to consider whether or not the numbers behind the key metrics are accurate and are giving you a true understanding of business performance.
You may also revise the list of KPIs you’re tracking in order to best utilise the data available.
The key is to be agile, and set a time frame for review KPIs as the data improves. Accurate data is crucial to ensuring you choose the right KPIs for small business owners.
There are some leading indicators that you can look at which will give you an idea of the shape the client’s books are in.
How long does the month close take?
Understanding how long the month close takes will give you insight into how efficiently the financial systems of the business are.
Analysing the current close will indicate where process efficiencies can be found, and give you a picture of how accurate the financial results are at any given time.
With technology developments such as bank feeds and easy reconciliation software like Hubdoc - large year-end adjustments shouldn't be necessary anymore.
How long does it take for invoices to be reconciled in the client’s source accounting system?
If invoices are being reconciled slowly, it makes business planning and scheduling difficult.
Predicting cash flow becomes near impossible if invoices aren’t entered into the source accounting system in an efficient and timely manner.
And if purchase orders or new contracts are not accurately reflected in the source accounting system, staff planning and project management will become increasingly difficult.
Having clean data in your client’s source accounting system is one of the most important, if not, the most important piece of the business advisory puzzle.
There’s no sense tracking KPIs and looking for insights if the data does not reflect the true financial position of the business.
What are your client’s personal and professional goals?
Regardless of whether the business owner is still a part of the business's daily operations or not, it’s important to build a business advisory plan which considers both your client’s personal, and professional goals.
The goals of your client won't always be directly tied to a short-term increase in profitability.
These goals can serve as the foundation for selecting some of the most important KPIs for your client's business.
Discussing these goals can help you uncover what is at the core of the business and the values of the owner, allowing you to align business advisory discussions accordingly.
Strategic goals are closely tied to the performance of leading and lagging indicators.
What are leading and lagging indicators?
Lagging indicators should be used to monitor the health of a business, signalling when changes in strategy may be required. Lagging indicators are an output or effect of business operations, while leading indicators are the non-financial inputs and levers that drive business results.
Client’s goal (lagging indicator) and complementary leading indicators:
I want to spend more time with my family
- Number of hours spent in the office
- Staff turnover
- Number of employees
I want to open a new office/location
- Number of leads
- Number of new customers
- Staff utilisation rates
I’d like to improve the financial health of my business
- Number of leads
- Number of new customers
- Number of sales calls scheduled
- Gross profit margin
- Net income
- Total revenue
Where is the business in its growth lifecycle?
A business’s lifecycle can be broken down into four distinct stages. Understanding which stage your client’s business is at will help you select the right KPIs for their business.
For example, a start-up business is likely to have very different performance measurement need, compared to established businesses. This will result in the selection of different KPIs.
Four different stages of the Business Lifecycle
Clients in the Start-up stage are likely to be concerned with attaining product/market fit and generate their first sales.
Speak to your client about the products and/or services they offer and how they fit into the market they’re trying to establish themselves in. Once you understand their product and market fit, ensure their KPIs are aligned with the goals they’re trying to achieve.
Businesses at the Start-up stage are usually focussed on building their brand awareness and marketing their products to their target market.
Focussing on monitoring the cash runway and achieving initial revenue traction is normally a priority so that they can move into the next Lifecycle stage, Growth.
In the Start-up stage, business advisors should consider tracking these KPIs
- Earnings Before Interest and Tax (EBIT)
- Cost Per Lead (CPL)
- Customer Acquisition Cost (CAC)
Faster business growth should mean more health checks. Businesses in the Growth stage are likely to need more guidance and deeper insights to ensure they remain on track.
Growing businesses usually need more staff, so hiring the right type and number of staff is going to be a priority, along with keeping costs under control and balancing creditor and debtors.
In the Growth stage, business advisors should consider tracking these KPIs
- Gross Profit Margin
- Operating Cash Flow
- Accounts Receivable Days (AR Days)
- Accounts Payable Days (AP Days)
The Shakeout stage can be identified as the stage after the Growth stage and when sales continue to increase, but at a slowing rate.
There are a number of reasons why a business may move from the Growth stage to the Shakeout stage.
This usually occurs as the market matures, competitors increase and as a result, profit margins decline. Businesses in the Shakeout stage may be likely candidates for acquisition or consolidation.
In the Maturity stage, business advisors should consider tracking these KPIs
- Gross Profit Margin
- Return on Capital Employed (ROCE)
- Operating Cash Flow
The Decline stage is likely to show slowing sales, cash flow will stabilise and the supply of products and services may meet or exceed demand.
Top-line performance and market share should be closely monitored. Now is a good time to look into finding new business opportunities with your client.
In the Decline stage, business advisors should consider tracking these KPIs
- Revenue Growth or Decline
- Market Share Percentage
- Number of New Customers
- AR Days and AP Days
Past and Future Challenges
What has been the business's biggest challenge to date and as their business advisor, what do you believe it will be going forward?
Building a business improvement plan which addresses the pain points of the business is a quick way to ensure you’re delivering value, and helping clients drive continuous improvement.
You should be selecting appropriate KPIs based on the challenges that your client is facing, keeping in mind any goals that they’re looking to achieve.
For example, focusing on too many profitability related KPIs may provide too many similar signals and limit the value of the services that you’re providing.
To get a holistic view of performance and the financial health of your client’s business, it’s important to track KPIs which are going to give other perspectives — these could include KPIs that measure cash flow, growth, efficiency and working capital management.
Cash flow problems are one of the biggest challenges for small businesses
The latest State of Small Business Cashflow Report published by Intuit, shows that 61% of small businesses globally, struggle with cash flow, and 32% of them are unable to meet their short-term financial obligations due to cash flow issues.
There’s a flow-on effect from this as well with Xero stating that more than 50% of trade credit invoices sent by Xero subscribers (invoices where payment is not due until at least one day after the day the invoice is created) are paid late.
These are customers of all sizes, and their payments arrive an average of 23 days after they’re due. Xero calculate the value of big businesses’ late payments to small business is about $115 billion a year.
It’s not surprising that one of the easiest and quickest ways to find cash in a business is by working to decrease accounts receivable days and increase accounts payable days.
Essentially, looking to collect cash quicker, and pay invoices slower (within the invoice payment terms).
Larger businesses are already using these tactics to tidy up severely ageing accounts receivables.
Cash Flow KPIs
Free Cash Flow KPI
Free cash flow is the cash left after subtracting capital expenditures from operating cash flow.
The term “free cash flow” is used because this cash is free to be paid back to the suppliers of capital.
Cash Flow Margin
A measure of the company’s ability to turn sales into cash.
Net Variable Cash Flow KPI
A measure of the additional cash that will either be generated or used by the next $100 of products or services that the business sells.
If the Net Variable Cash Flow is positive then for every additional $100 of revenue the business will generate cash.
If the Net Variable Cash Flow is negative, then for every additional $100 of revenue the business will require additional cash funding.
Managing inventory is another huge challenge for businesses
For businesses in the retail and hospitality industries, inventory can be a large line item on the profit and loss statement and the management of this inventory can raise complex issues and questions.
Estimates vary, but for the average small business, inventory can account for 15% of total assets.
Inventory can be upwards of 30% to 40% of total assets which is common for businesses with low fixed assets. Additionally, the average business spends between 25% to 35% of their top-line budget on inventory and associated costs each year.
Inventory Management KPIs
Inventory Days KPI
A measure of how efficiently the business converts inventory into sales. A lower number of days is generally an indicator of good inventory management.
A shorter time holding inventory has a positive impact on cash flow but be aware, a shorter result may also mean there is a shortage of inventory.
Conversely, a high result may indicate overstocking.
Gross Margin Return on Inventory KPI
Gross Margin Return on Inventory (GMROI) is a measure of the average amount that the inventory returns above what it cost to acquire that inventory.
GMROI assists to monitor the investment in inventory and the resulting gross margin earned by this investment.
A result higher than 100% indicates that the business is selling its products for more than what it costs to acquire them.
Cash Conversion Cycle KPI
The Cash Conversion Cycle (CCC) is a metric that expresses the time (measured in days) it takes for a company to convert its investments in inventory and other resources into cash flows from sales.
This KPI attempts to measure how long each net input dollar is tied up in the production and sales process before it gets converted into cash received.
Finding the right staff is hard, but keeping them is harder
Hiring employees that are a good fit for the organisation and role can be challenging.
Once hired, ensuring employees are engaged and fulfilled both professionally and personally poses additional challenges.
Failure to engage employees can lead to staff turnover, costing your clients time and money.
While this isn’t necessarily an issue traditionally dealt with by accountants, it’s important to take a holistic look at a business and pull together data to best assist clients with their overall objectives.
A recent report by PwC found Australia was the worst performer in a list of 11 developed countries when it came to staff leaving within a 12 month period.
The report concluded that 23% of Australian new hires will churn within 12 months – so nearly 1 in 4 of all new employees leave their job within 12 months of being hired!
The Institute of Managers and Leaders estimated that staff turnover in the first 12 months of hiring costs businesses in Australia $3.8 billion annually.
It’s unrealistic to aim for zero staff turnover, but a business should be able to hire and retain happy, engaged staff.
SurveyMonkey recently released some interesting statistics on combating staff turnover through customer engagement.
They found that when employees believe their employer has a high degree of empathy for their customers, 82% of employees believe that they will still be in their job in 2 years time.
When employees believe that their employer has a low level of empathy for their customers, only 66% believe that they will remain in their current role for less than 2 years.
“The more we can listen to the customer, empathise with the customer, celebrate and elevate the customer – and bring our employees close to the impact we are delivering for customers, the more likely they are to stick around and see meaning in their work." Leela Srinivasan, CMO of SurveyMonkey.
To manage employee turnover and staff engagement, business advisors should consider tracking these KPIs
- Employee NPS
- Turnover / Retention
- Vacation Days Used
This metric is used to gain an understanding of whether an employee would be willing to recommend your organisation as a place to work and the products/services they sell.
Ratings are from -100 to +100. Above 0 is considered good, above 50 is excellent and more than 70 is exceptional.
These metrics relate to the ability of a business to retain staff, and keep them engaged and happy.
This metric gauges the amount of time staff work on ‘billable’ projects, or hours spent working on items within their direct job description.
Vacation Days Used
The company culture created, can often be benchmarked against the willingness for staff to use their paid time off.
Looking at the percentages with which these days are utilised can help determine whether or not employees feel supported and comfortable with management.
It’s easy to see why accountants and bookkeepers looking to make the transition from a pure compliance model to a full service, business advisory model are overwhelmed with developing an initial business advisory process.
It can be intimidating at first to understand where to begin, but armed with this process, along with a number of predefined questions, understanding your client’s needs will prove less intimidating, giving you the best chance at delivering value through business advisory services.
A customised approach will yield the best insights and outcomes for your clients.
The difficulty often lies in implementing this bespoke approach in a scalable way. Remember to consider the short and long term goals of your clients, as well as their business as a whole when building out a process for developing a balanced scorecard.
Remember that each client is different and each will need a personalised approach to selecting the KPIs to match their business goals and personal goals.When you’re comfortable with your approach, check out our guide to delivering business advisory meetings with Fathom to understand how Fathom can be used as a foundation for your business advisory meetings.
Written by Allanah Miller
Allanah is a Product Manager at Fathom, having previously worked closely with our customers in Account Management over the last few years. As a qualified CPA, Allanah brings vital accounting acumen to help us build the best possible product. Before joining the team at Fathom, Allanah studied at UCLA and worked with PwC for three years as a Senior Tax Associate.