The business side of small business

Many small business owners are so busy with the day-to-day operations of the business that they can’t see the forest for the trees. They are underutilizing information about how the business is doing financially and, hence, are missing opportunities to improve the financial performance of the business.

This financial information is analogous to gauges on an automobile: they tell you how well the underlying business processes are working. They should function as an early warning system of problems requiring remediation or as an affirmation improvement efforts are being successful.

Each business needs to develop indicators specific to its processes, but several are widely used. In this article we are going to share some examples of helpful measures. It is important to note that these metrics are not taken from B-school textbooks, but rather are best practices drawn from successful business people.

A typical financial statement is a snapshot in time of what is going on. Graphing trends over time in such areas as sales, gross margin and units produced is analogous to a video, and provide a much clearer picture of whether things are getting better or worse. A second helpful approach – but difficult to format – is to separate fixed and variable expenses. Certain expenses should fluctuate with levels of business activity and others should not. This exercise also will force you to address expenses that should be variable that are, in reality, fixed. Opportunities for improvement come with this epiphany.  

Many people utilize certain ratios to help spot trends over several years. These are helpful because it’s hard to keep track of the cumulative impact of the changes made from one year to the next. Ratios such as sales/employee, unit product-ion/employee and overhead/employee are all helpful long-term benchmarks.

Many small business people let the cost accounting tail wag their pricing dog. They don’t put themselves in the shoes of a customer making a purchasing decision. A product or service ought to be priced to reflect value as perceived in the marketplace. Would someone discern a value difference proportionate to the price difference between your product and the others next to it? What is the competitive price point that will optimize your product’s take off the shelf? Value is a combination of price and quality. Most of the time as consumers, we make trade-offs between these two aspects but our purchasing motivation goes way up and we become raving fans when we get quality at a bargain price. The same is true of your customers.

Once you determine a price point, a projection of the net-before-tax profit of the product should be the basis of evaluating its contribution to the business. Pricing based upon a mark-up over cost is commonly used because it is easier to determine and accountants are comfortable with it. But it completely misses the perceived competitive value of the product or service in the eyes of the customer. It is helpful – but hard – to develop profitability by customer and profitability by product or service lines. This information is always surprising the first time you do it and usually leads to some different ways of thinking. Profitability should be calculated at the net-before-tax level to give a true picture of all the costs associated with the product or service line. Some people have difficulty fully allocating expenses but it is doable and follows easily once set up. Formatting information this way can also help reveal if increases or decreases in performance are due to take, costs, or volume.

Putting together these indicators can be time consuming at first but once in place can be easily updated and are invaluable to the health of your small business.

Co-authors Ellen Barnes Pfiffner and Sam H. Lane have a combined 50 years of management consulting experience with a multitude of Fortune 500 companies as well as with owner-managed and family-owned businesses. They can be reached at 214-789-3571 or at ellen@ebpbusinessconsulting.com.