July 2020

We are midway through the 2020 fiscal year.  Now is a great time to regroup and revisit your corporate goals in light of the new business environment. 

Good teams become great teams during these times because they make adjustments.

Let’s review:

  • Tell me about your first half operating performance.
  • Identify and examine key areas of strengths and weaknesses.
  • What are the goals and strategies we need to employ to finish the year strong?

Key points: Having trustworthy relationships with specific roles, defining your method for vetting ideas, and utilizing common principles in the decision-making process are the most important elements for success.

In my role as Chief Financial Officer, I identify areas for improvement and prioritize which areas bring the best returns.  As CFO, I develop a practice of evaluating Key Performance Indicators in conjunction with Financial Analytics.

Key Performance Indicators explain the past and are target driven; whereas, Analytics are forward looking and value change.

Both practices simplify the relationship between data series.  When interpreted professionally, they convey key insights that can be measured against a baseline or standard.  

When an organization is in tune with its metrics, clear, concise feedback simplifies decisions.

To help you understand the process, let’s use the following example:

Software-as-a-Service, SaaS, is a start-up with $2.5mm. First year sales would be expressed as 1H2020. How should SaaS begin looking at 2H2020?

One of the important performance indicators for a SaaS company is the Recurring Revenue

Total Number of Paying Users

(x) Average Monthly Revenue Per User

 Monthly Recurring Revenue (“MRR”)

Sounds easy, right? 

Yet, information can seem complicated when you break down that same expression into:

  • New MRR – New Customer Revenue
  • Add-On MRR – Expansion of services for existing customers
  • Contraction MRR – Customer downgrades
  • Churn MRR – Lost Revenue from Cancellations
  • Net MRR – Total recurring at end of each month

Looking at data during an extended period, a trained eye will notice trends and overlay it with other meaningful data (i.e. Customer Usage) to establish helpful cause/effect relationships underlying company financials

Yet, a critical element for CFOs and their financial teams is not just being an “Information Supplier”, but converting into a “Problem Solver”.

This is where Financial Analytics plays an important role; giving decision makers a complete view of the issue at hand, what the probability of potential outcomes might be and how those outcomes will impact financial performance.

Mastering this discipline gives companies better insights into forecasting cash flows, scenario planning and managing budgets to name a few.

But what if your organization doesn’t identify as a SaaS company?

Below are 3 metrics that transcend industry to industry and are useful places to begin:

  • Revenue Per Employee & Profit Per Employee (Productivity)

This metric measures how efficiently an organization uses its employees to generate Sales and Profit.  For industries that are more labor intensive, this metric will be lower than those industries that require less labor.  The tenure of the company also plays a role in this ratio. 

The key is to see historical trends and compare them to those companies within your industry.  Ultimately, the goal is to grow Revenues at a faster rate than Labor.

  • Cash Conversion Cycle (Liquidity)

Managing working capital is a fundamental task for any organization.  However, this painstakingly technical and often times under-managed step is often underutilized.

When observing this metric, the goal is to shorten the time period between Payment (Cash Out) & Collections (Cash In), thereby, reducing the time taken to convert Working Capital into Cash.

Let’s take a manufacturer witnessing its working capital accounts (i.e Account Receivable, Inventory, Account Payable) increase over a given period.  After causing stress on Cash Flow which leads to increased borrowings, a larger drag on performance from increased debt service and interest payments will result.

In this scenario, one might consider aligning Bonus Compensation to Account Profitability which would incentivize the sales force to collect on outstanding accounts receivables.  This practice can reduce cycle times and bring Cash to the bank.

  • EBITDA – Earnings Before Interest, Taxes, Depreciation & Amortization (Effectiveness)

EDITA is a very important number for your business because ESITA is used in many applications. Used internally, I can measure profitability and compare margins & ratios of companies of different sizes. 

EDITDA is also used as a proxy for cash flow and a represents a language that is familiar to key stakeholders such as Lenders & Investors.  For example, EBITDA is a metric Lenders will use to measure a company’s ability to pay-back borrowings.  The more stable your EBITDA trends, the better.  A more volatile EBITDA, the riskier the borrower.

Furthermore, a common practice when acquiring a target company or selling a business is to use a multiple of EBITDA as a key valuation metric.  In these cases, you’ll find companies presenting an adjusted-EBITDA which removes one-time expenses, irregular charges or non-recurring expenses.  The practice is intended to accurately portray a normalized EBITDA by eliminating abnormalities.

To summarize: the most important parts of this process are having trusted relationships in specific roles, having a defined method for vetting ideas and utilizing common principles in the decision-making process.

If you would like to have a Modern Day CFO in your corner, give us a call.

Stephen Perkins