In the July 12, 2022 edition of Accounting Today, Justin Hatch described five key performance indicators (KPI’s) for a business and why they matter. They are: operating cash flow, revenue growth, profit margin, revenue per unit, and customer satisfaction. The article is outstanding and presents the reasons why each of these are so important to businesses. I want to add a few additional comments about this critical data from a managerial accounting perspective:
- KPIs belong on the organization’s balanced scorecard. The Kaplan and Norton strategy map (for instance, see this article.) has four operating perspectives, one of which is the financial perspective. It is the strategy map that drives the balanced scorecard. Should these financial figures rise to that level of importance (and it is in fact difficult to see how they do not) in your organization, they should definitely be on the balanced scorecard.
- Know what the cash flow statement tells you. Operating Cash Flow can be found on the least understood of all financial statements: the statement of cash flows. It is one of the three main sections of that statement, with investing and financing cash being the other two. All members of management should be conversant with this statement. Operating cash flow is one of the main determinants of the value of a business. The lack of an operating cash flow will not only lower the valuation of the business but will result in its ultimate extinction when investors and lenders run out of patience and cease funding operations continuously resulting in cash deficits.
- Understand why sales growth or reductions are occurring. Revenue growth is also one measure of an organization’s value. It is critical to understand why sales are growing or not growing. Accordingly, a deep dive needs to be made into the components of sales revenue especially when budgeting time rolls around. All budgets and forecasts start with the revenue line so it is worth understanding the various possibilities of potential revenue growth. Revenues can be increased in four ways:
- Increased sales of the same products to current customers;
- Increased prices of the same products to current customers;
- Sales of new products to current customers; and
- Sales to new customers.
Understanding this can help management budget and plan for revenue growth.
- Great care needs to be exercised when analyzing profit margin. Profit margin also needs to be disaggregated and analyzed in its component parts. One of the hardest things any organization can do is try to increase the sales of its products while maintaining the margin on those products. Yes, it is possible within what accountants and economists call the relevant range, but I have found that to be a very small range. In most cases, increased unit sales will result in decreasing prices and therefore decreasing margins. This is a basic law of economics. The demand curve for any product is downward sloping. To sell more you need to lower prices. You might answer by saying wait, suppose there are economies of scale in the production process? Won’t this keep margins up if the cost of production decreases? That is possible, but step costs do increase outside of the relevant range. Variable product costs may increase as vendors charge more for higher volumes of purchases. Labor costs could go up as overtime increases. It is no wonder that Wall Street puts a premium on the stock prices of companies that seem to hold their margins while increasing sales. In short, when budgeting, extra diligence is necessary when projecting gross margin for a changing sales forecast. Beware of excessive optimism!
- The value of a company is also driven by its relationships with its employees, vendors, and of course its customers. If you believe the value of a company is dependent on the net present value of its cash flow, then customer revenue is all the more important. Maintaining customer relationships is key to maintaining the value of your company. The loss of a customer can be thought of as a potential loss of company value. It is extremely hard and costly to find a new customer. That is often the hardest way to grow sales. Losing a customer, whether intentionally or unintentionally, should be a moment of introspection for management.