If you’re just watching over cash that’s good but it’s not enough. Companies that succeed are the ones who adapt. By now you’ve seen the typical advice amidst the COVID-19 crisis – collect you’re A/R’s, defer payments, minimize inventory, etc. – but how do you know if the changes you’ve made are efficient? How do you know they’ll be profitable? You need to know that the changes you’ve made are sustainable, profitable and efficient and know that you’re set up for success after all of this is behind us. How can you compare efficiencies between what may have been your banner year and right now?
KPI #1: Income Per Employee
This metric is a measure of management efficiency. The ratio is derived from dividing the total Operating Income by your number of employees. To get more precise, you may want to divide the OI by the total number of FTE. In other words, if two of your employees are at .5 FTE (1/2 time) the collectively they would be 1.0 FTE. This allows the clearest picture of true Income Per Employee and allows you to benchmark effectively against industry standards. The ratio will change drastically from industry to industry as labor demand isn’t the same from one business segment to the next. You may have a high gross margin company in SaaS or manufacturing but a lower one for a medical services provider. Depending on the industry it may be useful to calculate Revenue Per Employee.
It will be critical to calculate this metric for prior periods and current periods to compare your efficiencies. If you’ve adjusted your labor force, you can maintain the same efficiencies even if you’ve experienced a dip income.
WHERE IT GETS TRICKY: Employee turnover (of which there is currently plenty) can influence the calculation and is different from normal employee attrition. Be careful, get some help, or hire a pro.
KPI #2: Customer Acquisition Costs
How much should I spend on marketing? The answer: it depends. This is a particularly important metric to SaaS companies and Venture Capitalists. There are many standards out there that vary by industry. While you may have experienced a dip in customers recently it’s ok to adjust your marketing budget. In its most basic form, Customer Acquisition Costs (CAC) can be calculated by dividing all the costs spent on acquiring customers – salespeople’s commissions, sales and marketing expenses, promotion items, etc. – by the number of customs you acquired during the same time period.
WHERE IT GETS TRICKY: Each industry and each company have varying sales cycles. Bigger ticket items or services equal longer sales cycles. Therefore, dividends from marketing expenses may not be recognized in the same period in which money is expended. In addition, you may not yet have enough historical data in this new landscape to get a real handle on it. You can always hire a pro to put together a robust proforma around this KPI.
The correct sales and marketing strategies almost always have a Return On Investment – even in down-turns.
In start-up-land, CAC and Lifetime Value of a Customer (LTV) can make or break a company and attract or deter investors.
KPI #3: Liquidity Ratios
There are a handful of liquidity ratios and three of the very pertinent ones are Current Ratio, Acid-Test ratio and Cash Ratio. All of them give insight into a company’s viability. Lenders finance good liquidity ratios, Investors invest in good liquidity rations and companies with good liquidity ratios survive.
Current Ratio:
Current Ratio = Current Assets / Current Liabilities
The Current Ratio is an indicator of how well a company can meet its obligations that must be satisfied within 12 months.
Shoot for a ratio of 1.2-2. Below 1 means you don’t have enough assets to cover short term liabilities.
Acid-Test Ratio:
Acid-Test Ratio = (Current Assets – Inventory) / Current Liabilities
To determine if a company can meet short term obligations with assets more easily convertible for cash, use the Acid-Test Ratio.
This can vary widely by industry but shoot for 1 or greater.
Cash Ratio:
Let’s talk turkey. How much cash do you have in relation to what you need to meet your obligations and survive?
Cash Ratio = Cash + Cash Equivalents / Current Liabilities
Yes, you must watch your cash. Yes, you must know if you can make payroll next week. Yes, it’s healthy to take all of this seriously. However, if you’re checking your operating account daily and seeing if you have enough to pay bills for the next little while, you’re not doing enough. You don’t have enough information. Albert Einstein wrote, ‘The measure of intelligence is the ability to change.’ Effective change, however, comes by way of information.