Your business plan must include a series of budgets based on Managerial and Financial Accounting, discussed in the previous blogs.

However, we know that once you start a road trip, you may encounter unforeseen problems and opportunities. There may be construction detours, heavy rains that force you off the freeway or you remember this is a bluebonnet season and take a farm road to enjoy the view.

It is a bad plan that admits of no modification. We live in a dynamic world. Our customers change, their wants and desires change, and our competitors’ strategies change in response to our entry. Flexibility and mid-course correction based on new information are the hallmark of a good planning process.

In order to know if you are on track, you need sign posts. In business, they are known as Key Performance Indicators or KPIs. KPIs are used to assess the present state of the business and to prescribe a course of action.

The adage "What gets measured, gets done" is true. KPIs focus attention on the tasks and processes deemed most critical to the success of the business. KPIs are like levers you can pull to move the organization in new and different directions.

Accordingly, choosing the right KPIs is reliant upon having a good understanding of what is important to the organization. 'What is important' often depends on the department measuring the performance - the KPIs useful to finance will be quite different than the KPIs assigned to sales, for example.

Because of the need to develop a good understanding of what is important, performance indicator selection is often closely associated with the use of various techniques to assess the present state of the business, and its key activities. A very common way for choosing KPIs is to apply a management framework such as the balanced scorecard.

A company’s top management will analyze many areas of business operations, including:

FINANCIAL: Measures the economic impact of actions on growth and profitability

  • Cash – Bank balance, cash flow forecast – this is a MUST.
  • Sales Revenues; by segment
  • Margins - gross margin, net margin; by customer or product segments
  • Costs – variable, fixed, by category, such as compensation, maintenance, delivery
  • Receivables aging; bad debts
  • Inventory turnover, aging mix

CUSTOMER: Measures the ability of an organization to provide quality goods and services that meet customer expectations

  • Status of existing customers; Customer attrition
  • Demographic analysis of individuals (potential customers) applying to become customers, and the levels of approval, rejections and pending numbers.

INTERNAL BUSINESS PROCESSES: Measures the internal business processes that create customer and shareholder satisfaction (project management, total quality management, Six Sigma).

LEARNING AND GROWTH: Measures the organizational environment that fosters change, innovation, information sharing and growth (staff morale, training, knowledge sharing). View some examples of KPI’s used in various functions within a company.

FINANCIAL RATIOS: At times, it is more informative to look at ratios of two numbers and compare them to benchmarks in your industry.

  • Liquidity ratios measure the availability of cash to pay debt.
  • Activity ratios measure how quickly a firm converts non-cash assets to cash assets.
  • Debt ratios measure the firm's ability to repay long-term debt.
  • Profitability ratios measure the firm's use of its assets and control of its expenses to generate an acceptable rate of return.
  • Market ratios measure investor response to owning a company's stock and also the cost of issuing stock. These are concerned with the return on investment for shareholders, and with the relationship between return and the value of an investment in company’s shares.

Here are formulas for many standard ratios. You should have a handful of KPIs that are appropriate for your own business and use them to measure the actual progress at least on a quarterly basis and make mid-course corrections if necessary.

Here are a few examples:

Key Factor

Probable Cause

Possible Corrective Actions

Lower revenues
  • Fewer customers
  • Each customer buying fewer things
  • Lower Price
  • New competition
  • Increase advertising
  • Adjust your product mix
  • Increase prices if you can
Lower margin
  • Lower Price
  • Higher Product Costs
  • Increase prices if you can
  • Adjust product mix
  • Find alternate suppliers
Higher inventory
  • Product mix out of line with customers needs
  • Study inventory ageing by product
  • Get rid of slow moving products by aggressive discounting
Higher costs
  • You didn’t study your costs properly during planning
  • You have unexpected expenses
  • Analyze costs by category
  • If labor, try to convert salaried employees to commission-based or cut down employee hours
  • Try to renegotiate lease

  If the key factors are better than expected, corrective action may still be required in the form of more rapid growth or raising prices.

There may be times when midcourse corrections are not easy or quick. You may find that you have focused on a wrong niche or a wrong location or a better financed competitor is trying to run you out of business. Targeting a new market niche or moving to a different location may not be easy, cheap or quick, but it must be considered as soon as possible before you run out of cash.

Proper preparation prevents poor performance but rigid adherence to a plan made obsolete by events is worse than no plan. A plan is as good as its underlying assumptions; all of which could change as you get new information. Flexibility and mid-course correction based on new information are the hallmark of a good planning process. Appropriate Score Card is a way to respond rapidly to an ever changing environment.

About the Author(s)

Raj Mashruwala

Raj joined SCORE in 2003, after he retired from Lyondell Chemical Co. where he was Director of Corporate Strategic Planning.  He brings 28 years of experience with Atlantic Richfield and its spin offs in the areas of engineering, plant operations, projects coordination, marketing and strategic planning.

Mentor, SCORE Houston

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