“So, what are you going to ship this month?” “Um, I don’t know. Probably what we shipped last month.” “Was last month a good shipping month for you?” “I guess so.” This unfortunately is a typical exchange when speaking to owners or executives of many small to mid-sized companies who do not know their numbers!
What do we mean by knowing your numbers? Since you are there to make money, it seems simple, right? And knowing your numbers includes not just your financial numbers but also quality, delivery and customer scorecard numbers. Still, at the end of the day (or month), it is about the financial numbers and “making money.”
Your numbers should start with an annual financial plan for the current fiscal year. Typically, you would build a financial plan that begins with annual revenue forecasts that you get from your customers.
From there, you lay out an income statement, balance sheet and a cash flow statement. Again, the question of knowing what you are going to ship this month is contained within that financial plan. You should know your monthly revenue target and be measuring the company’s performance against that target for any month. Everyone from the office to the shop floor should know the target. Companies should monitor their performance in terms of orders received, current backlog and revenue/shipments on a dashboard that tracks daily, weekly and monthly performance against the plan they have set. If everyone knows what the goals are, they know what must be accomplished every day!
As a note, many companies have financial covenants from their lenders that need to be maintained monthly. There is no better way to predict if you might get into trouble during the next 12 months than projecting out your covenant ratios. And if you see an issue, you will have time to address or communicate the issue.
We just talked about the annual financial plan, but what about the longer-term, strategic plan? Many companies fail to create a strategic plan. When working with companies on strategic plans, we help them set the strategic initiatives that will drive the company’s growth and financial performance in the current fiscal year and into the future. Each strategic initiative should be measurable, and we would identify key performance indicators (KPIs) that could be set and monitored on a regular basis. For example, a key strategic initiative within a foundry may be to reduce the scrap rate from X to Y. The company would set a target for scrap reduction and monitor its performance against that target monthly.
Having a financial and strategic plan in place with financial and operational performance targets is critical to the success of any business. As the old saying goes, “If you don’t know where you are going, how are you going to get there?”
Margins are important to a business. A company should be monitoring its gross margin performance against the monthly financial plan. If you are not meeting the plan’s gross margin target, you should be investigating why. Is it a pricing issue or is it a cost issue? You should also be evaluating gross margins by customer and by part number on a monthly and annual basis to ensure there is no margin erosion.
Identifying margin issues will lead you to review material and labor costs and other operational issues that may be occurring in producing certain parts.
How about accounts receivable and inventory management? What are you measuring or monitoring? For accounts receivable you should be tracking your account agings month over month for any payment issues and measuring your monthly DSO (day sales outstanding) for positive or negative trends. Inventory numbers to monitor include overall dollars within categories of raw materials, work-in-progress (WIP), and finished goods and how they have changed month over month and compared to your financial plan. What if you have growing finished goods and yet you are a made-to-order company? Why is this happening? Some other inventory KPIs to monitor are inventory turnover (on a 12-month rolling average) and the age of your inventory within the categories of raw materials, WIP and FG.
If you have a bank or other lender line of credit agreement, you may have financial covenants that are required to be tracked and reported monthly, quarterly and/or annually. Knowing these numbers and status against bank-set minimum covenants is critical to ensuring continued access to working capital.
KPIs for Operations are numerous and again should be used to track your performance against key strategic initiatives and areas you deem critical to success. Some examples of what you may want to be tracking are scrap rate, metal yields, price per pound or price per ton, rework, returns, past-due orders, on-time delivery, production/labor hour, overtime dollars and hours, energy costs, quality (defects per 1,000 parts), machine downtime, PMIs, OOE (overall operations effectiveness) and OEE (overall equipment effectiveness) just to name a few!
Certainly, every business should be tracking past due orders and on-time delivery, as they are critical to meeting the expectations of your customers. Knowing these numbers is critical to understanding if you have a good problem or bad problem. If you have past due orders because you recently received a large influx of orders that production is struggling to keep up with, that is a good problem that is a good problem––as long as you can address the situation and solve it quickly. If you have past-due orders strictly due to operational inefficiencies, that is obviously a bad problem and must be corrected quickly to meet customer expectations. These operational inefficiencies may be identified in some of the suggested metrics above.
In terms of your business’ valuation, measures such as EBITDA (earnings before interest, taxes, depreciation and amortization) are tracked by companies and their stakeholders. We will discuss more on this subject in a future article.
Knowing your numbers is key to your success. You can start with a few KPIs and build from there.
Knowing where you’re going ensures you’ll get there!
Robert Silhacek and Michael Wise
Originally Posted July 8th, 2021 at Modern Castings