In my recent blog, how tracking revenue goals alone can set your business up for failure, I discussed the importance of using indicative, proactive performance metrics to complement the traditional financial performance metrics your company may be using. But, what are good indicators to use and how can you use them to mitigate potential problems or even contain a situation before business results are impacted? In this blog, I will cover three types of indicative, proactive metrics your business could monitor to allow you to determine whether or not your company is on track to hit its overall financial goals and put remediation plans in place in case they are not. These types are customer retention, cash flow, and working capital.
Recent research conducted by Sage tells us this: attracting new customers and keeping them happy are as important as growing revenue. These are also the top two areas of concerns for business leaders.
Not surprising, right? Customers are the primary source of company revenue. But, in the age of the customer, every business should have certain customer metrics as part of their key performance indicators. These metrics can signal customer behavior, which means they are often indicators of revenue performance and cash flow.
Customer churn is an important business performance metric, and it can signal contraction. The full cost of customer churn includes both lost revenue and the marketing costs involved with replacing those customers with new ones. Surveying customers for NPS or customer satisfaction are important, but often the results come in long after the opportunity has passed to resolve a potential customer issue.
Do you know which customers may be at risk of churn? How do you focus on customer retention? Here are some methods you should consider:
Begin with identifying your top tier customers. This can be by customer revenue, customer lifetime value, or customer profitability. It may be important for you to have rosters for all three, or more, given that each grouping offers its own value. For example, customers with the highest lifetime value may not be generating the most revenue this year, but their loyalty may be an important fact in your year-over-year growth or contribute to other factors like brand awareness.
Second, analyze indicative, proactive metrics of their behavior such as:
- Percentage of projects at risk
- Average project overrun in terms of days
- Percentage of work un-invoiced
- Percentage of invoices that were received but rejected
- Date of the last contact
Action this information. Identify which customers should get most of your attention based on the ones you perceive are the most likely to churn. Is there a customer project you should reprioritize or an order you should place to keep a customer on-track? Regroup your customer teams to build action plans to alter the way you’re currently serving these customers and deliver the experience your team has promised to the customer.
Drive these insights into the organization. Institute changes in the organization to reduce the risk of retention going forward. This can be done by further segmenting customers into groups, perhaps by industry or product/service line purchased; analyzing these same metrics in step two above and determine if there are any trends that you notice. For example, you may see that customers who are supported by certain sales teams are continually not receiving communications from the company which could signal the need for more resources on that team or tools to help automate these communications.
With these insights, you will know which customers are at risk of attrition, often a huge unknown, and devote time to your team and that customer to get the relationship on the right track. You will also gain insight into what projects are underway, and which team members are involved in serving a particular customer. With all of this customer data throughout the customer lifecycle—from the opportunity to project completion to receiving payment—you’ll be able to spot potential issues before they become a reality.
It is a sobering thought, but most businesses fail due to issues surrounding cash flow. In fact, research from U.S. Bank suggests that 82 percent of small to mid-sized companies fail due to poor cash flow management and lack of understanding of cash flow. Cash flow is the amount of cash the company generates within a specific period. It gives us insights into a company’s ability to generate revenue.
Being unable to meet financial obligations can spell disaster for any business. Having key insight into cash flow is crucial for any business owner or finance manager, especially if the company is seeking to invest in future growth opportunities. Unfortunately, metrics like free cash flow are static, and companies need to be able to predict how free cash flow would increase or decrease based on the shifting dynamics of their business.
To truly gain insight into cash flow and the future financial health of your business, you need to be able to build scenarios around projects in progress, jobs that haven’t yet started, opportunities that might close soon, and more. By understanding all of the elements of your business that impact cash flow, you’ll have greater visibility into the financial health of your business—which builds confidence when growth opportunities arise.
Measure indicative, proactive metrics like:
- Revenue from jobs in progress and revenue from jobs not yet started. Assuming the customers for these projects do not pay on high amounts of credit, this could give you a sense of incoming cash to the business.
- Percentage of sales on credit. If you have a high percentage of sales on credit, then you may look profitable but haven’t received cash for sales. This can end up hurting your free cash flow.
- Days payable outstanding (AP/ cost of sales). This indicates the average length of your collection times from suppliers. As days payable outstanding grows, AP declines or grows more slowly than sales, becoming a source of cash.
- Inventory turnover ratio (sales/inventory). This indicates how efficient your team is at turning inventory into cash, or inventory relative to sales. Similarly, you could use the day’s inventory outstanding metric.
Build scenarios for how your cash flow will be impacted. Evaluate how accounts receivable, and ultimately your cash account, could be improved by upcoming invoices and the payment terms for customers. The more you can leverage historical and trend data to influence your predictions, the better. For example, if you know that historically you close 60 percent of the sales opportunities in your pipeline, and you know those customers pay according to their payment terms then you can be more precise in your modeling of how current sales opportunities could impact cash flow.
Action these insights. If you have a large potential amount of revenue from jobs in progress then perhaps you should reprioritize other work. Or, if you have a relatively low average days payable outstanding, determine if you can work with suppliers and vendors to renegotiate payment terms. You could also focus your sales team on closing those current opportunities, rather than building a pipeline
Cash flow can also increase by improving efficiency ratios that effect changes in working capital. Working capital provides a snapshot of the present situation. On the one hand, working capital is significant because it is a measure of a company’s ability to pay off short-term expenses or debts. On the other hand, too much working capital means that some assets are not being invested for the long-term, so they are not being put to good use in helping the company grow as much as possible.
To truly monitor and measure working capital, you need to have a good handle on your accounts receivable. How is your A/R performing? How quickly do your best customers pay? How slow are your slowest paying customers? What are the average days to pay across all customers? How many days in A/R are your invoices—segmented by project type?
Improving your working capital can be achieved optimizing your A/R process: this can be done by automating billing and invoicing, requesting payments in person, understanding outstanding payments, and knowing when and how to restructure payment terms. If you can optimize A/R and move a late payment at the end of December to an early payment at the beginning of October, you’ll not only increase working capital, but you’ll be better able to invest that money to grow the business.
More methodically, here are some steps you can follow to identify and mitigate potential issues resulting from poor working capital.
Measure indicative, proactive metrics such as:
- Days sales outstanding. Improved collection practices drive down days sales outstanding (A/R divided by total credit sales x number of days in a period), thus decreasing accounts receivable.
- Average debt collection days. This tells you how quickly your customers pay once they have been invoiced.
- Average days to process a sales transaction. This is the number of days it takes you to invoice and process the payment from a customer. This is often calculated according to a company’s payment terms and how a sale is confirmed.
Diagnose issues. Set performance goals for these metrics, based on values that are appropriate for your business. For example, for days sales outstanding you typically do not want the average to exceed your average payment terms by more than half. So, if you operate on average payment terms of 30 days and you are seeing the payment in 45 days you’re doing pretty well.
Analyze trends in your performance. For example, is it a certain group of customers that typically fall into delinquent status? Or perhaps they fall into delinquent status when they purchase a certain product such as a product that requires a longer onboarding time. Spotting trends can help you get closer to identifying the root cause of an issue. If your average amount of days to complete a sales transaction is longer this month than last, consider the reason. You may have internal processes that you have that need to be improved.
Action this information. You can improve your A/R, debt collection and credit management processes with process efficiencies, or even technologies. You may also find that you need to renegotiate payment terms with customers so that you’re in a better position to optimize working capital and in a better cash position.
To summarize, encouraging your organization to monitor these types of metrics that both indicate how your business is performing to achieve its overall financial performance goals and allow you to put plans of actions in place to ensure your business stays the course can help your business gain better control. This allows you to ensure you and your teams are spending time on the activities that matter and gives you confidence about the direction your business is moving in.