Financial Metrics for Managers
by: Gerry A. Michael, CPA, CMA, MBA
Its pretty clear that this is not a happy time in the graphic arts industry. Weve seen the economic climate this bad before, but knowing that things have been worse before is little consolation to a company in the midst of the battle now. The simple fact is that in the next few years, a lot of companies in the industry are likely to be gone. And as my company sees it, the bindery and finishing sectors of the industry will be hit even harder than the rest of the industry. Thats not being alarmist or pessimistic. Its simply a fact.
Surviving in a Difficult Economy
The difficult economy, combined with the changes in the marketplace that the industry has been struggling to respond to for decades, means that the number of firms in the industry is likely to contract. Some firms are probably not going to make it. But in previous downturns, once the economic storm clouds clear, the firms that have weathered the storm enter a period of robust growth and strong profits. Difficult business times seem to produce stronger companies. But is it really that simple? Probably not.
Whats the difference between those that survive, and those that dont? Obviously, the answer to that is complex. Success or failure cant be attributed to just one thing, and in my experience, sometimes it comes down to simple luck. But one thing I have observed over the years is this: Successful firms know a great deal about themselves, they understand the keys to their own success, and they are able to react quickly to change.
Basically, they know whats important, and they measure it, monitor it, and react to it with speed and confidence. What is it that gives these firms an apparent advantage over others? They tend to use relevant, timely, and accurate information about themselves and the environment in which they operate to improve the quality of decision making, to provide early warning of impending difficulties, and to find and take advantage of opportunities for improvement. Put another way, they know what metrics are important, and they use them in their business.
The Problem with Financial Statements
So which metrics are most important to owners and managers? Thats a trickier question to answer. One of the biggest reasons is that my own profession, public accounting, has hijacked the entire accounting world! Simply put, CPAs dont try to produce information for the use of management. The approach of all Certified Public Accountants is the maintenance of an accounting system and reporting philosophy designed to meet the needs of the public, not management. And practically every accounting system in existence today has been developed based on these principles. Where did we go wrong?
The answer requires a long and detailed review of how accounting evolved in the business world, from its origins over 5,000 years ago in ancient Sumeria. In fact, some scholars actually believe that the oldest known writing was developed to help ancient bookkeepers communicate commercial matters! Accounting has evolved to meet the needs of the time, focusing first on simple merchant (retail) accounting systems, often using barter, then adapting over time as the economies of the world changed and became more sophisticated. But then, about 200 years ago, something quite dramatic happened. Business entities began to seek investors and lenders to supplement the capital of the owners, as businesses became both larger and more complex. These investors and lenders began to impose reporting requirements on the businesses, requirements that would enable them to compare one investment opportunity to another. Enter the profession of Public Accounting.
Now, understand that Im proud of my profession and I have great respect for the work that we do. The profession imposes very challenging and demanding requirements on its practitioners. Its just that I also realize that there is nothing about being a CPA that qualifies a person to advise management. Actually, thats the arena of Management Accounting, and it is best done by a Certified Management Accountant, or CMA. Even the accounting profession acknowledges that there is a difference!
What this means for an owner or manager is that financial statements are inadequate tools for managing any business by themselves. While its important to have statements that are both accurate and timely, they dont provide what is needed for managers. What traditional statements (income statement, balance sheet, and statement of cash flows) do help to determine is how the organization performed as a whole over a certain period of time. What they dont do is help management understand why the performance was what it was and how it can be changed. The entire focus of financial statements in public accounting is the fair presentation of the results of operation for the company in total. Little analytical or diagnostic information is presented, nor is it intended.
Choosing the Right Metrics
So what type of metrics should be used? Forgive the classic consultants answer, but It depends. However, there are criteria for management information that can definitely be stated as relevant in all cases.
- Timeliness is the information current? This should mean a matter of days, not weeks. What data is reviewed each week?
- Relevance does it measure things that count? Labor dollars are hard to manage, but not labor hours. Which is being looking at?
- Usefulness does it serve a purpose going forward? For instance, what good is looking at gross profit margin when it includes both fixed costs (rent) and allocated costs?
- Action-focused does it support a plan of action? In other words, can the results be changed through management action?
- Repeatable often overlooked can the metric be measured at different times with the same qualitative values? Only then can the effects of change be monitored.
- Reliability sometimes thought of as accuracy does it really measure what it purports to measure?
Based on those criteria, what are some of the things I think every manager should look at on a regular, consistent basis? Examples might include the following:
Planned Capacity Utilization What percentage of bought (i.e., paid for) direct labor hours are actually charged to a job, not including time on reruns or above estimates? This is critical in any manufacturing company, and especially for firms in all phases of graphic arts. A company has to sell the capacity it is paying for to succeed. When it doesnt, the company has excess capacity and needs to react to it, either by reducing capacity (layoffs) or by pricing more aggressively.
Price Realization This is calculated as actual job prices divided by target price for the same jobs. Management has to price to the market, but also should track the cumulative effect of market pricing, to be able to predict the financial results.
Estimate Turnaround Time How much time elapses between a customers request for an estimate or quote and the company providing one? This should be in hours, not days, and it can be tracked more easily than management might think.
Job Turnaround Time Perhaps more obvious, but how much time elapses between the order and job shipment?
On Time Rate This may be the most important metric for managers. What percentage of jobs are shipped on or before the original promised date (rather than the date the client accepted after the first deadline was missed)?
The above can be powerful tools in the hands of managers who are willing to use them. They address some of the most critical issues in the industry today:
- How well does the company serve its customers?
- How well does the company use its resources?
- How well is the company pricing its product or service?
Notice that not a single one of these metrics can be found in traditional financial statements. But the data should all be available with minimal extra work, and it should be generated internally.
One final note: Sometimes when I present this to clients, their response is disappointment. They seem to want a longer list of things to watch, as if the more information a manager looks at, the better the company will do. I disagree. Looking at a large number of reports is not only a waste of time in my experience, but can provide conflicting information, thereby eroding the value of the whole process. Focus on a small number of metrics, make sure they are understandable, and stay with them.
These are just examples and should only be used in conjunction with more traditional reports, since understanding the effects on the company as a whole remains important. But a change in those reports only occurs when management metrics such as these are employed, and that should be everyones goal.
Gerry Michael, CPA, CMA, MBA, is president and co-founder of GA Michael & Company, PS, a Seattle-based CPA and consulting firm specializing in the graphic arts industry for over 25 years. Michael has been a frequent speaker at industry meetings, including the recent BIA Mid Management Conference in Las Vegas, and is author of numerous articles on industry financial issues. In addition to public accounting services, his practice provides merger/acquisition, valuation, and strategic planning services to its clients in Washington, Oregon, and California. His firms website, www.gamichael.com, includes many of his past articles, and he can be reached at firstname.lastname@example.org.