The 'metric' system Featured

9:37am EDT August 20, 2004
If you can't measure it, you can't manage it.

This age-old adage is as applicable today as it was when it was first coined. It is incumbent upon senior management to drive the revenue numbers higher every day, every week and every month, while at the same time absolutely controlling the company's expenses.

Managing your company without a clear understanding of how the financial decisions you make every day affect your company is akin to driving a NASCAR racecar while looking only in the rearview mirror.

Many years ago, there was a shift in the accounting world to tax-based accounting to keep up with the requirements of the Internal Revenue Service. This has enhanced IRS compliance but has been a disservice to managers and business owners trying to run their company by the numbers.

Measuring business success is a two-step process; the first is developing a realistic variable budget, and the second is capturing and utilizing the data to make informed decisions regarding the operation of the business.

To effectively measure the performance of a company, the owner or senior management must identify the critical variables that affect operations. This process starts with identification of the distinct revenue streams the company has or would like to develop. Historical data, coupled with competitive analysis and market trends, allows for realistic forecasting. This process also allows senior management to hold the sales function accountable for specific performance and to fine-tune marketing efforts.

The next step is to identify the variable costs -- labor, labor burden, materials, subcontractors, equipment rental, expense, scrap and warranty and applicable royalty expense, etc. -- within the operation. By carefully analyzing variable costs and measuring the results on a percentage basis, as opposed to dollar amounts, senior management is able to react and control variable costs related to revenue fluctuations. The information generated from these categories is a direct reflection of the ability of your line managers and employees to manage and control costs.

The impact of overhead is often misunderstood, and too often, the consequences are fatal to the company because management did not understand the direct relationship between overhead and gross margin.

There are two types of overhead that management must take into consideration: indirect and general/administrative overhead. Indirect overhead expenses are the costs associated with performing the functions of product production, but the costs are spread over the entire organization. Examples are product development costs, estimating expense, supervisor wages, consumable supplies, government compliance, uniforms, equipment maintenance and associated labor, auto expense and small tools and supplies.

General and administrative overhead typically accrue independent of business operations. Examples include accounting expense, depreciation, bank charges, interest expense, office rent, office payroll, owner's payroll, office supplies and professional fees.

By carefully identifying and forecasting the company's critical variables, developing a realistic budget, driving the numbers daily and measuring performance on a weekly basis, senior management can understand and control the numbers critical for company success. Mike Rudd (mike.rudd@ipa-iba.com) is director of client services for International Profit Associates. IPA's 1,700 employees offer consulting services to businesses throughout the United States, including Alaska and Hawaii, as well as in Canada. Reach Rudd at (847) 808-5590 or at www.ipa-iba.com.