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These Numbers, Used Properly, Can Help You See Problems in Advance

Accurate financial statements are critical to operate any company successfully. By themselves, though, they do not provide all of the needed information to run a business effectively. Often, by the time problems show up in the financial statements, the damage is done.

Consider a business that makes and ships widgets. Suppose widget shipments start to go out late. Will this problem show up in the financial statements? Eventually, it will. The income statement will show a decline in sales. Unfortunately, by that time, the customers will have left. It will be too late to get them back.

Related: 7 Deadly Sins of Financial Management (Infographic)

What’s needed is a set of daily, weekly and monthly metrics that show the details of what is going on in the bowels of the business in a timelier manner. If the owner of the widget company had seen a weekly report that contained the percentage shipments that were on time, she would have seen the problem weeks or even months earlier. She could have taken action to correct the problem before customers took their business elsewhere.

We wish that we could provide a uniform set of metrics that would work in any business regardless of the industry, but there is no “one-size-fits-all” solution -- no simple formula that will pop out the needed metrics. Each business is unique and will require metrics tailored to the specific situation. However, following the set of guidelines below can be extremely helpful in constructing a robust set of metrics for any business. Metrics should:

1. Be layered in a pyramid. At the top level, the reports should focus on a small number of measures that will provide a view of the entire business. For example, at the very top of the pyramid, the focus might be on return on assets. If there is an issue at the top level (e.g., a decline in ROA), the owner can drill down into lower levels of the pyramid that contain more detail to determine how to address the problem.

The lower ROA will have resulted from either lower profits or a decline in asset utilization. If the problem is reduced profit, the cause will be lower revenue, reduced gross margin or an increase in overhead expense. The owner will continue to dig deeper until he/she finds a problem that can be corrected.

Related: 6 Things You Didn't Know About Your Financial Statements

2. Be “MECE” (Mutually Exclusive and Collectively Exhaustive). Mutually exclusive means that measures at a given level of the pyramid should not overlap. Don’t measure the same thing in two ways. Collectively exhaustive means that, taken together, the metrics at any level cover all of the important elements of organizational success. Don’t leave gaps that will allow problems to go undetected.

3. Be measurable and stable. Metrics that are objective and quantitative are more valuable than subjective, qualitative assessments.

4. Be viewed in context. If sales in the northeast region were $78,000 in May, is that good or bad? One can’t possibly know without context. An isolated number is most often meaningless. Context usually comes from a comparison to history, a budget or competitors. If we told you that last year’s May sales in the northeast had been $65,000 and the budget for this year was $70,000, you would quickly conclude that it was a good month.

5. Contain checks and balances. Don’t allow improvement on one important metric at the expense of another. For example, reducing inventory at the expense of on-time deliveries is unacceptable. Real progress requires that improvements on both of metrics simultaneously or at least that one be held constant while the other improves. They balance each other.

6. Have point accountability. One person and only one person should own each metric. If more than one person is responsible, no one is accountable. If more than one person owns a metric, break it into components with a single owner.

For a business to continue growing, the principal must delegate responsibility and authority. To do this effectively, an appropriate set of metrics must be in place. This can be tricky business, but following the guidelines outlined above will help business owners avoid unpleasant surprises.

Related: Make Financial Statements Useful With These 6 Tips