How Are We Doing?

Measuring performance, one process at a time.
BY JACK L. OTTENHEIMER

EXECUTIVE SUMMARY

  • NEW, FAST-GROWING COMPANIES often can't balance the dual goals of building sales and managing profitability. Not until a business hires an experienced CFO can it focus on ways to find such a balance. But there are steps even a young enterprise can take, on its own or with the help of its CPA firm, to achieve some balance even before it can afford a full-time CFO.

  • THE MANAGEMENT BUZZWORD used to describe those steps is performance measures a process that gauges current performance and looks beyond historical financial performance. Put simply, performance measures can help to determine how the company is doing now and how it can plan its future.

  • THE FIRST STEP IN DEVELOPING performance measures is to decide what to measure. Begin by looking for those activities that, taken together, are the foundation of sales and profits.

  • WHEN DEVELOPING MEASURES, be careful not to include too many. Consider limiting the number of measures to between five and eight. If there are too many, managers lose focus.

  • AFTER ESTABLISHING and evaluating the results sufficiently, you may find you can link compensation and bonuses to performance. But be careful to put emphasis on quality, not quantity.
JACK L. OTTENHEIMER, CPA, is vice-president, finance, and CFO at ABL Electronics, Corp., Hunt Valley, Maryland. He is a former chairman of the Maryland Association of CPAs management of an accounting practice committee. His e-mail address is jotten@charm.net.



The challenge for a young, fast-growing company is to balance the dual goals of building sales and managing profitability. Often it's not until a company grows large enough to hire an experienced CFO that it can focus on ways to find such a balance. Still, there are steps even a young entrepreneurial enterprise can take, on its own or with the help of its CPA firm, even before it can afford a full-time CFO.

The management buzzword used to describe those steps is performance measures a process that gauges current performance and looks beyond historical financial performance. That's not to suggest that historical statements aren't valuable, but a company's success is based not only on where it's been but also on where it's going. Performance measuring tools provide the information needed to help a business look ahead so it can design a program to take it into a future that management plans, rather than a future that fate imposes. Read on, and well show you how easy it is to implement.

WHAT TO MEASURE
The first and most important step in developing performance measures is deciding what to measure. Begin by looking for activities that, taken together, are the foundation of sales and profits. For example, to increase sales, solicitations must be stepped up. That may mean conducting more sales calls. The company also will need to strengthen the sales effort, and that means finding ways to measure what it means to be effective.

Replacing customers is expensive, so most companies work to retain their customer base by keeping clients satisfied: reducing shipping and billing errors and selling quality products. The number of errors, the number of products returned and the reasons for the returns are easily tracked. This information tells the company two things: whether there is a problem and, if so, its dimensions. Managers can't begin to address such issues unless they have this information on a timely basis.

To see how performance measures might work for your company or client, look at two examples, a wholesale company and a chain of karate studios.

THE WHOLESALE BUSINESS
A wholesale business primarily focuses on sales and fulfillment, sell the product and then deliver it to the customer. To track those functions, the performance measures must be focused on a number of metrics, the management accountants' term for those business parameters that are quantifiable. Look at sales first. The company should monitor the following for each salesperson: number of orders taken, sales volume in dollars, gross profit on each sale, average size of order, number of new and repeat customers, number of outbound and inbound telephone sales calls. And then, to determine how well the company fills its orders, it must track the number of shipment errors.

Here is what a typical sales department performance measure scorecard would look like:

Sales Department Performance Measures

  Daily Weekly
$ sales orders taken x x
$ and % gross profit on orders taken x x
$ average order size   x
Number of orders taken   x
Number of new customers   x
Inbound phone calls taken x x
Outbound phone calls made x x
Number of product selection errors x x
 

With this information plus a basic break-even calculation, the sales manager can easily determine the minimum targets the sales force must reach for the company to be profitable. If that information is to be useful, the manager needs daily feedback on results. A report might look like this:

Daily Sales Department Report ($ in 000s)

  Monday Tuesday Wednesday Thursday Friday Total Average
$ sales $100 $75 $125 $90 $110 $500 $100
$ GP $50 $30 $60 $45 $75 $260 $52
% GP 50% 40% 48% 50% 68% 52% 52%
Inbound calls 100 200 175 210 150 835 167
Outbound calls 50 65 45 55 25 240 48
 

The fulfillment manager needs to know how much of each product is being shipped, the number of shipments going out on time, the number of incomplete shipments and the number of shipping errors. By focusing on the exceptions, the manager can train the staff better and determine whether inventory levels are sufficient.

Here is what a typical fulfillment department performance measure scorecard would look like:

Fulfillment Department Performance Measures

  Daily Weekly
$ of orders shipped x x
Number of orders shipped x x
Number of orders shipped late x x
Number of partial shipments x x
Number of shipping errors
(address, method)
x x
Number of product errors
(wrong item, quantity)
x x
 

A daily budget of sales and gross profit also could be included in the daily sales department report. The weekly report would look very similar, with weekly totals going across the top of the page for a rolling four-to-eight-week period.

Depending on the particular business, other measures might be added. For example, the number of incoming calls can tell the company whether the phone system and sales staff can handle the volume during a peak period. For this, the company would want to know how many calls come at different hours of the day. Maybe there aren't enough operators or salespeople to handle peak periods and sales are being lost because potential customers get busy signals and hang up.

Fulfillment managers need different information. For example: how much product is being shipped each day, number of shipments going out on time, number of incomplete shipments and number of product-selection mistakes. By focusing on the problem areas, managers can better train the staff. These statistics also can help determine whether inventory levels are sufficient by looking at the number of partial shipments.

A fulfillment department report might include dollar value of orders shipped, number of shipment errors (wrong item, quantity or address), partial shipments and number of product errors.

Daily and weekly reports should be easy to read. Graphing the data can make the presentation more readable. Measures are most useful when compared from period to period.

In our sample business, the sales and fulfillment managers should see their information daily, but upper management might need to see it weekly. The executive version might also need less information.

KARATE STUDIOS
How should the CPA design performance measures for a chain of karate studios? The studios focus is to sell memberships, keep clients interested in the program and ensure they progress through the program while maximizing the capacity of the teachers, space and class times.

Maintaining monthly statistics of the number of enrolled clients will enable managers to make a quick projection of future monthly revenue. Unlike the wholesaler model, most of these measures don't go into financial statements, yet they are critical to operations.

To measure sales and client-retention performance, the manager should monitor the number of introductory lessons, number of new clients, attendance, total number of enrolled clients and class size by both teacher and age group.

To assess teacher performance, the following would be tracked: the number of classes taught, average number of clients per class, average retention rate and teachers progress with their own martial arts studies.

Here's what a typical sales and retention performance measures scorecard would look like:

Sales and Retention Performance Measures

  Daily Weekly Monthly
Number of introductory lessons x x x
Number of new students x x x
Number of students attending x x x
Total number of enrolled students x x x
Class size by teacher and age group   x x
 

And here is what a teacher's performance measure scorecard would look like:

Teacher Performance Measures

  Weekly Monthly
Number of classes taught x x
Average number of students per class x x
Average retention percentage x x
Progress with their own martial arts studies   x
 

Experienced operations people have good instincts about what works well in their company, and they should be directly involved in developing the metrics to monitor. The process of developing and establishing a system of performance measures is a consultative process, so ask for their input.

When developing measures, the top manager or the CPA consultant shouldn't overdo it; measure only processes that are significant. Consider limiting the number of measures to between five and eight. If there are too many, managers lose focus, and this process is about staying focused on the key day-to-day items. If too many measures are selected, the amount of time necessary to quantify them may outweigh the information's value.

After establishing and evaluating the results, the managers may find they can link compensation and bonuses to performance.

The number of measures for a company will vary with the size and complexity of the business. But if, as in the examples, there are only six performance measures per department, there may be only 30 significant measures for an entire company.

A word of caution: Performance measures can lull managers into using them to meet short-term goals or quotas to the detriment of long-term progress. Also, a poorly implemented system can put employees under tremendous pressure, make for an unpleasant work environment and create a piecework mentality. People respond well to goals and performance targets, but if management places undue emphasis on quantity, then quality, and business, will suffer.

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