Carol has taught college Finance, Accounting, Management and Business courses and has a MBA in Finance.
How Can We Measure Performance of a Business?
Sometimes business owners and managers get so busy working in their business that they forget to stop and analyze what is working and what the company can do better. In this lesson, we'll look at some ways a business owner or manager - we'll call him 'Joe' - can monitor his business performance so that issues and opportunities can be addressed before they negatively impact the bottom line.
Here are several tools Joe can use to measure performance of his company:
Budgets are one of the best known performance management tools. They can be as simple as a revenue and expense goal that the business compares actual results against each month.
Many businesses do very detailed business plans, which allows them to measure the impact of specific things that happen on their bottom line. A well-designed plan will have expectations in terms of employee productivity (especially in the sales department), customers and their buying habits, expenses needed to support the business, staffing requirements, and anticipated large capital expenditures.
These detailed plans are generally compared to monthly and year-to-date financial reports, and variances are identified and analyzed. Joe, for example, might notice that revenues last month are lower than anticipated. He can then dig into the specific details and find that sales of Product B are lower than planned and the selling price is also lower than expected. Armed with this information, he can go and speak to the sales team and try to determine why Product B isn't selling at the levels anticipated. Once he has some idea of what's happening, action can be taken to try and generate more sales of Product B - or to revisit the budget and redesign plans based on new assumptions.
Metrics or KPIs
Metrics or key performance indicators (KPIs) are standard defined numbers or ratios that can be compared to company performance. Examples might be sales quotas or revenue generated per employee.
The specific metrics used in a company depend on the business drivers. In an auto repair business, for example, important metrics might include average revenue per job and jobs completed per service technician. A change in either of these can lead to a dramatic increase or decrease in revenue for the shop.
When Joe is determining the metrics to use in his performance measurement, he should start with the biggest cost and revenue areas of the business. Once he finds them, metrics can be developed around those areas to provide indicators of current results. For instance, if Joe's business is a consulting company, he will probably need to measure billable hours per consultant or number of jobs per employee. If Joe's business is a restaurant, he will probably need to measure seats per day and revenue per seat.
Once the metrics are determined, they should be calculated and reviewed regularly to watch for problems and trends.
Comparative ratios are metrics or KPIs for groups of companies or industries. A specific company can compare its results to these ratios to see if it is performing better or worse than its competition. Industry performance information is available from many published sources, including the U.S. Government.
To return to Joe - he might locate industry performance information online and incorporate those ratios into his monthly reporting to see how his company lines up against others in the same field.
Surveys are questionnaires given to employees, customers, or vendors to determine their opinion of the company's performance. Customer surveys are common and are used to determine if customers feel they are receiving good service from the company, if the products are considered high quality, and if the customer is likely to buy from the company in the future. There are also often comment areas where customers can request help for specific issues they are unhappy with.
Joe might hire an outside company to contact a group of customers and determine their satisfaction with the company's products and services and determine any areas where improvement is needed. He might also survey current employees to make sure they feel the company is a good place to work. With this information he can refine business plans and develop action plans to address any issues.
Survey recipients are often promised their responses will be anonymous so they feel they can freely give information without repercussions. To do this, outside companies may be hired to design and administer the survey, or the company could use one of the Internet-based survey services to design their own questionnaire and collect results.
There are many ways to measure business performance, including comparison to budgets, comparison to ratios, and surveys. All of these can be effective in giving information to company management about what is working well and what needs improvement. The key is to review the information regularly and take action if needed - before the company experiences negative results it can't recover from.
After you are done with this lesson, review what you learned:
- Describe the importance of budgets to business performance
- Identify and explain the use of metrics or key performance indicators (KPI)
- Recall the purpose of comparative ratios
- Recognize what surveys do for business performance
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