Measuring business performance

Your business success can depend on developing and implementing sound financial and management systems. Many businesses fail because of poor financial management or planning.

A review of your financial performance can help you reassess your business goals and plan effectively for improving the business. When conducting a financial review of your business, you might want to consider the following:

• Cashflow - this is the balance of all of the money flowing in and out of your business. You should ensure that your forecast is regularly reviewed and updated.
• Working capital - have your requirements changed? If so, research the reasons for this movement and assess how this compares to the industry standard. If necessary, take steps to source additional capital.
• Cost base - keep your costs under constant review. Make sure that your costs are covered in your sale price - but don't expect your customers to pay for any business inefficiencies.
• Borrowing - what is the position of any overdrafts or loans? Are there more appropriate or cheaper forms of finance you could use?
• Growth - do you have plans in place to adapt your financing to accommodate your business' changing needs and growth?

Measuring your profitability

One of the most important areas of your finances you should review is your profitability. Most growing businesses ultimately target increased profits, so it's important to know how to measure profitability. The key standard measures are:

• Gross profit margin - how much money is made after direct costs of sales have been taken into account, or the contribution as it is also known.
• Operating margin - this lies between the gross and net measures of profitability. Overheads are taken into account, but interest and tax payments are not. For this reason, it is also known as the EBIT (earnings before interest and taxes) margin.
• Net profit margin - this is a much narrower measure of profits, as it takes all costs into account, not just direct ones. All overheads, as well as interest and tax payments, are included in the profit calculation.
• Return on capital employed - this calculates net profit as a percentage of the total capital employed in a business. This allows you to see how well the money invested in your business is performing compared with other investments you could make with it, like putting it in the bank.

Other key accounting ratios

There are a number of other commonly used accounting ratios that provide useful measures of business performance. These include:

• liquidity ratios, which tell you about your ability to meet your short-term financial obligations
• efficiency ratios, which tell you how well you are using your business assets
• financial leverage or gearing ratios, which tell you how sustainable your exposure to long-term debt is

Finding and retaining customers is a crucial task for every business. So when looking for areas of your business to start measuring and analysing, it's worth asking yourself if you know as much as possible about your customers.

Revisiting your markets

A strategic business review offers you the opportunity to stand back from the activity outlined in your plan and look again at factors such as:

• changes in your market
• new and emerging services
• changes in your customers' needs
• external factors such as the economy, imports and new technology
• changes in competitive activity

Looking at your business from your customers' perspective can help you avoid getting sidetracked as you consider your options for growth.

Customer feedback is essential - the more you know about what your customers think and want, the easier it will be to handle increased numbers of customers. Look for as many ways of capturing this information as possible, including:

• sales data - what your customers choose to buy (or not to buy) provides the clearest indication of their preferences
• complaints - but remember that many customers will simply switch suppliers before making a complaint
• questionnaires and comment cards - a very useful source of information, so consider using incentives to encourage more customers to complete them
• mystery shopping - having someone pose as a customer for research purposes can give a very clear sense of how well you are performing
• social media - this is a useful way of gaining customers' feedback. However, if you receive negative feedback from a customer, it can work in your favour if you deal with the customer's comments. It shows that you care about your customers.

Asking customers for feedback helps to identify where improvements can be made to your products or services, your staffing levels or your business procedures

Widen your focus beyond current customers

Selling more to existing customers might be the easiest way of increasing sales, but most businesses aiming for significant growth will need to find ways of reaching new groups of customers.

So knowing more about sections of the market you haven't yet tapped is crucial.

As your business grows, the number of people you employ is likely to increase. To keep on top of how your staff are doing, you may need to find more formal ways of measuring their performance.

Measuring through meetings and appraisals

Informal meetings and more formal appraisals provide a very practical and direct way of monitoring and encouraging the progress of individual employees.

They allow frank exchanges of views by both sides and they can also be used to drive up productivity and performance through setting employee targets and measuring progress towards achieving them.

You should consider annual employee appraisals to monitor how an employee is developing and to get feedback on their opinions of the business.

Regular staff meetings can also be a very useful way of keeping tabs on wider developments across your business. These meetings often give an early indicator of important concerns or developments that might otherwise take some time to come to the attention of your management team.

Quantitative measurement of employee performance

Looking at employee performance from a financial perspective can be a very valuable management tool. At the level of reporting for the overall business, the most commonly-used measures are sales per employee, contribution per employee and profit per employee.

These measures shouldn't be thought of as an alternative to the broader appraisals outlined above, but can flag up issues that might later be explored in more detail in those meetings.

Expressing employee performance quantitatively is easier for some sectors and for some types of worker. For example, it should be quite easy to see what kind of sales an individual sales person has generated, or how many units manufacturing employees produce per hour at work.

But with a bit more effort, these kinds of measures can be applied in almost any business or sector. For example, using timesheets to assess how many hours an employee devotes each month to different projects or customers under their responsibility gives you a way of assessing what the most profitable use of their time is.

Benchmarking is a valuable way of improving your understanding of your business performance and potential by making comparisons with other businesses.

Who to benchmark against

It is usually helpful to compare yourself against businesses in the same sector. However, your market position and your objectives, among other things, will affect the specific comparisons you want to make.

For example, a small business in a crowded sector may want to benchmark itself against average performance levels in the sector, but a business targeting rapid and significant growth may choose comparisons with an established market leader.

You can also benchmark internally within your business. For example, comparing absenteeism rates between departments may enable you to spread good working practices from the best-performing areas of your business.

What to benchmark

In general, the same rule applies to benchmarking as to choosing which performance measures to use. You should focus on those areas that drive business success in your sector - your key drivers.

How to benchmark

You should have ready access to all the figures for your own business, so the main challenge with benchmarking is often the process of finding external data for your comparisons.

There are a number of sources for this kind of information:

• your trade association is a useful starting point, as these organisations often collate sector-wide statistics
• commercial market reports may provide greater detail, although these can be costly

Using your benchmarking data

Benchmarking data should be used in the same way as any other performance measurement data you generate - to drive improvement in the way your business operates.

Typically this will involve setting targets to help you reach the benchmark values to which you aspire.

When you have been running your business for a while, you will probably have a clearer idea of your competitors than you had when you first started. Conducting market research and competitor assessments to gather more information may cost time, money and effort, but there are many benefits to knowing more about what your competition is doing.

What you need to know

The type of competitor information that will be really useful to you depends on the type of business you are and the market you're operating in. Questions to ask about your competitors include:

• who they are
• what they offer
• how they price their products
• what the profile and numbers of their customers are compared with yours
• what their competitive advantages and disadvantages are compared with yours
• what their reaction to your entry into the market or any product or price changes might be

You will probably find it useful to do a strengths, weaknesses, opportunities and threats (SWOT) analysis. This will show you how you are doing in relation to the market in general and specifically your closest competitors.

How to find out more

There are three main ways to find out more about your competitors:

• What they say about themselves - sales literature, advertisements, press releases, shared suppliers, exhibitions, websites, social media, competitor visits, company accounts.
• What other people say about them - your sales people, customers, local directories, the internet, newspapers, analysts' reports, market research companies. It can also be useful to look at their interaction with customers on social media.
• Commissioned market research - if you need more detailed information, you might want to commission specific market research via an organisation such as the Market Research Society (MRS).

Read our guide on Setting targets and key performance indicators.