There are no simple secrets in business, but this one comes close
I’m sometimes asked what the secret of building a great small business is. And that question always reminds me of the wonderful quote by HR Mencken:
“For every complex human problem, there is a solution that’s simple, easy to understand, logical, sensible… And wrong.”
There is no such thing as a single secret of great business. There are a bunch of factors that all have a role to play though, and one of those is controlling the numbers. My most successful clients all have one thing in common, and that is that they manage their business by the numbers. That being the case, which are the key numbers you should focus on in your business?
There’s a few that are obvious:
- Net profit before tax (also referred to as EBIT) in dollars and percentage
- Your bank balance
- What you’re owed and what you owe
- How much of what you’re owed is inside your trading terms (30 days, 60 days, 90 days)
Then there’s one number people sometimes forget about and that’s Gross Profit (GP). GP is income minus the direct costs of producing that income. So if you’re selling milk, it’s the total revenue of milk sold minus the total cost of all the milk you’ve bought.
GP is the King of the numbers, because it is the greatest indicator of the health of your business. You know what your overheads are going to be over the year, wages, rent, electricity, insurances, etc. They might change a fair bit from week to week, but not from year to year.
Let’s say you expect them to be $250,000 per year, less $5,000 per week. So by looking at your GP, you can know every week if you are doing fine or not. If you only made $4,500 Gross profit last week, you know you need to make $5,500 GP next week just to break even over the year. My most successful clients all focus on GP.
Fun with Ratios
Here’s another number that can really change your life: The Debtor Days Ratio. It’s a ratio number that’s derived from your balance sheet. Here is a Wikipedia link that explains how you calculate it. It expresses in a single number how long it takes you to get paid on average. The number might be 36.5, which means that on average it takes 36.5 days for you to get an invoice paid.
Focusing on driving the Debtor Days Ratio down and keeping it down will have a massively positive impact on the cashflow in your business, your bank balance in other words.
All of the previous numbers come out of your bookkeeping system, but there are also a bunch of really important numbers that you obtain from different sources.
For example, there are some useful numbers in relation to sales, that you may need to obtain by recording them in a spreadsheet or that you can pull out of a CRM system.
The first one of those is simply the number of inquiries. How many inquiries do you get every week? The next one is the conversion rate. Of the xx inquiries we get every week, what percentage turn into actual business?
Predicting the future
The reason these numbers are so powerful is that they allow you to start to predict the future. If you know that you’ve had 100 inquiries last week and your conversion rate is 25%, then you know you’ll likely have 25 jobs come in the door from those inquiries. If your average sales value is $375 for example, those 100 inquiries will probably generate $9.375 worth of sales.
If your average GP is 50% of revenue, you know you have to generate $10,000 of revenue to break even (50% x $10,000). You will likely fall short by $625 and you are going to have to make that up in the following week(s).
Knowing your sales numbers and conversion rates gives you an early warning system for what’s going well and not so well in your business.
Your small business is special
Every business has its own special numbers that will allow you to keep your finger on the pulse. What matters is that you sit back and ask yourself: what are the key processes and systems in my business that I need to keep an eye on?
Let me give you an example from a service industry. A key determinant of profitability in service industries such as plumbing or washing machine repairs is how often technicians have to go back to a job to fix a problem with the work that was completed.
The margins in these industries are low. Too often it happens that something goes wrong on a job and the technician has to go back the next day and fix the problem, free of charge. “Call-backs” play havoc with Gross Profit in such businesses.
A business owner who manages the business by the numbers will know what the “Call-back” number is in his business from week to week and from technician to technician. Managing that number is key to building a healthy business.
Have you thought about the key numbers in your business?
Your business and your life will change forever when you make managing by the key numbers your first priority… I promise you.