Which Financial Indicators Must Entrepreneurs Monitor?
The entrepreneurs’ mind and energy are focused on building a business. It could mean creating a product, service or a model that serves the target customers. Most entrepreneurs are not trained to be financial experts, though they have high expertise in their own area.
The stories of the initial days of struggle of an entrepreneur are not uncommon. They face an uncertain future, changing market conditions, technology change, rising costs and competition from new sources.The failure rate of new ventures is substantially high. Various studies put the failure rate of new businesses between 30% to 70% over first three years.
One of the key reasons for failure of new business is that the entrepreneurs simply run out of the cash before they reach their break-even scale. You can’t avoid this unless you can find partners with deep pockets,like the one’s that today’s tech start-ups seek to find. If you have those funding partners lined up, you can afford to burn the cash for years; however not all businesses model themselves to appeal to the investors with deep pockets and high appetite for risk.
In the absence of access to huge cash and to financial experts, which are the key performance indicators that the entrepreneurs must track, to ensure that they survive long-enough to break-even and make it big?Here are a few which I recommend based on my experience.
- Cash flows: It is said that, “sales is vanity, profit is sanity, and cash is reality”. A new business will likely invest in creating capacity and hence will have net cash outflow on account of investing activities, e.g., acquiring machinery, equipment, rights to intellectual property etc. However, every entrepreneur must focus on generating positive operating cash inflows. A cash flow statement should be drawn up preferably every month, or at the least,every quarter. The cash flows should be compared to the previous months/quarters to see how the business is moving. Any sign of deterioration should be carefully examined and acted upon.
- Product/service price: As an entrepreneur, one frequently encounters situation where the customer demands lower price. These requests are made with a promise to restore the price to the “usual price” if the product or service is found to be of acceptable quality. A higher volume of purchase is promised if the price is lowered. Lower price offered by a competitor is often quoted as a reason for inability to procure from you. As a newcomer struggling to prove your product or service, the temptation to reduce the price and clinch the deal is very high. One can’t and need not say no to every such request; if there is good enough reason, the price may have to be lowered. However, there must be a rigorous monitoring to see that the lowered price is indeed giving the result desired. Tracking the product price and profitability is therefore key. A new business can’t afford the luxury of low price that an established player with deep pockets can.
- Fixed costs: Higher “committed” or “fixed” costs of business is found to be a key reason for many new businesses bleeding cash in their operations. These typically include lease rentals, salaries, finance costs, and payments to outsourced services providers that are not linked to volume of procurement. The ratio of fixed costs vs variable costs should be regularly monitored. As many costs should be moved to variable costs as possible. Outsource your finance and accounting to avoid having an accountant on payroll. Hire a venue for your programs on hourly or daily basis instead of leasing it for long-term. Engage free-lancers for your work; they offer higher expertise and you pay only when you have work to give. Link as much of your costs to your revenues as possible.This will help reduce the costs when the sales orders are not coming through.
- Receivables:Extending credit is a standard business practice in many industries when the dealings are between two businesses (B2B markets). The entrepreneurs have no option to follow the industry practice. It is a must, however, that the receivables are rigorously followed up for recovery. The ageing of the recoveries should be monitored to check whether any discounts should be offered to get cash quickly and avoid potential bad debts. Money stuck with customers may lead to severe cash crunch through the profitability and sales look good on paper.
As an entrepreneur, setting KPIs to measure these four variables and track them over time will ensure that the business doesn’t run out of cash without early warning signals.