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A CFO’s Secret Revealed to Analyzing Financial Statements

All Articles, Financials, Key Numbers, Reporting

I’ve been studying and analyzing financial statements going back to my days at KPMG Peat Marwick in St. Louis.

But I’d have to say I started doing it for fun (yes, fun) when I would receive hundreds of annual reports mailed to my home thanks in part to my membership with the National Association of Investors Corporation. That would have been in the early 1990s when I only had access to Quattro Pro, the Lotus-like product that ran on the 286 processors (man I’m old).

More than 20 years later, I still love reading and studying financial statements. Give me 60 months of financial data, and I can tell you a lot about a company in less than 5 minutes. I can even pretty much sum up the personality of the CEO and the underlying culture of the organization.

And for the first time ever, I’m going to give you a brief glimpse of what I do when I obtain financial data from a brand new client. So let’s dive in.

Sales

In the screenshots below, we’ll be looking at two companies–Growing Big (in orange) is a $25 million organization whereas Boring Company (in blue) is twice that level in sales.

Normally, I’m only looking at the business I’m taking on as a client, but I want to make some important points about good vs. bad numbers, and showing two companies allows me to do this.

Accordingly, let’s start with sales. The very first thing I want to know is if sales are dropping, growing, or just moving sideways as such:

While Growing Big is half the size of Boring Company, whose growth rates do you like the best?

And while we’re at it, let’s look at some compound annual growth rates:

I should have mentioned, my new client is Growing Big, and while their sales growth rates look great, we’re far from finished.

What if this high-growth company is hemorrhaging cash? Or what if the balance sheet is upside down? Don’t worry, we’ll arrive at those answers pretty quickly.

Revenue Per FTE

Financial analysts are not supposed to have favorite ratios. We can’t since we possess holistic mindsets. Still, I’m a major fan of Revenue Per FTE, especially if I can see the trend.

This simple metric tells me so much about the CEO I’m taking on as a client. I can easily gauge their business maturity especially if the number is moving in a positive direction.

First, Revenue Per FTE is a slow-moving metric. It’s like watching ketchup being poured from a bottle. By laws of financial gravitational force, it’s impossible to budge. Then again, it depends on just how operationally and technologically savvy the CEO is.

Let’s take a look:

Not only is Growing Big growing in sales, they have something up their sleeves with respect to a rising Revenue Per FTE. I mean, “Geesh, $1.4 million?” Okay, so I made up the numbers. But the performance is still impressive.

In case you were wondering, Apple’s is around $2 million per FTE and Google’s is $1.2 million (thereabouts).

Amazon? Not quite $.5 million.

And Boring Company’s? Well, pretty boring at $.2 million and moving sideways. I think it’s fair to say there’s more technological advancement at Growing Big–maybe. I’ll follow-up with the client later to inquire about customer satisfaction levels. This will ensure we’re not being stingy on adding staff while risking deteriorating service levels with customers.

Gross Margins

Again, I’m only looking at the company I’m analyzing. I’m not doing any type of benchmarking. Accordingly, I’m looking at whether the numbers are going up or down. Trends are important.

And that leads us to gross margin. In my opinion, it’s the most critical margin on the income statement, yet the hardest to manage and even maintain during times of turbulent economic headwinds. If this number cannot be constantly tamed, then profit margins go out the window.

Here’s what we have to look at:

So we can clearly see there’s no significant variation from period to period.

Margins driven by commodities with mismatches in supply and demand can easily wreak havoc on the bottom line. My biggest concern with Boring Company is that there’s very little room for error with those smallish gross margins.

When there’s an obvious and natural ceiling on an industry’s gross margin, that means CEOs have to watch selling, general and administrative costs like a hawk. Again, there is little room for error. Cost containment and continuous improvement activities are tantamount.

Profit Margin

Every single business I’ve worked with is either a partnership (LLC) or an s-corporation (and most are LLCs too). And that means all the bottom line numbers are before taxes. So, the numbers below do not include payments to Uncle Sam:

As with other numbers we’ve looked at, I’m looking for strange movements or crazy gyrations. In both cases, there is minimal variation.

I have more to say about the bottom line, but that will be within the context of several key numbers on the balance sheet I’ll address later.

Before we move on, see the natural progression of my analysis? I’m starting with the P&L. I started at the top and then moved my way downward.

This is a macro-level analysis. So we’re not getting into the weeds. Remember, these are the numbers I focus on first.

So let’s move on to the balance sheet.

Return on Equity (ROE)

I debated on whether to include ROE. Since I look at it (and very quickly), I thought I’d better do so.

Why the hesitation? Tax accountants are notorious for butchering balance sheets. That’s fine for tax purposes, but not for GAAP reporting (GAAP with small letters).

Most small business owners make their internal financials match the tax numbers at the insistence of the tax accountants. That means retained earnings are generally understated due to accelerated depreciation charges. When that happens, ROE can yield some silly-high results.

Also, owners who lack financial sophistication and who think it’s their bank’s sole purpose to fund business growth at a whim tend to pull out too much cash from their annual earnings. This drives down equity and accordingly yields a crazy-high ROE as well.

Call me a fool, but I still look at these numbers:

Surprise, surprise. Not much year-over-year change. But what if Growing Big’s ROE was rising rapidly?

Then I’d be looking for some financial engineering. In those cases, I care the most about an excessive growth rate in debt which can drive an ROE increase.

And so that’s the next number I look at. Accordingly, I look at debt to equity. In the matrix below, we see no noticeable growth:

So let’s put the two pieces together. In reality, the image below is how I look at both numbers in the same view. I’ve filtered my data on Growing Big, and the image reveals our ever-so-slight increase in ROE is not being driven by debt growth. When that happens, that means cash, more than likely, or other assets are growing.

Return on Assets

Speaking of assets, let’s start seeing how each ownership manages it precious resources. I’ll state here that I typically don’t spend much time on working capital in this high-level analysis.

Return on assets will always be lower than ROE. But Boring Company’s numbers are way, way too small. We’ll need to investigate later.

I’m placing my money on excess and/or dead inventory. Remember the stodgy Revenue per FTE for this company? It’s not poor performance on capital expenditures. Well, that’s my theory, but one that needs to be studied.

Asset Turnover

Another way to measure asset performance is to look at the Asset Turnover trend.

Brett Daffron of Commerce Bank (Kansas City) is one of the most financially-savvy bankers I’ve ever worked with, and he loves this number.

Growing Big finished the year at 1.19. And what does that mean?

Brett will tell you that for every dollar that Growing Big has in assets, it’s generating $1.19 in sales. And I can certainly tell you that’s a poor number:

To put this simple ratio in perspective, Wal-Mart’s recent Asset Turnover was more than 2.0. While there’s much to like about Growing Big, perhaps we’ve found their biggest weakness–asset management (I prefer the term asset stewardship).

Cash, Cash, Cash

We haven’t hit cash yet. And it’s part of my high-level analysis. Plus, I keep it super simple.

Here’s the first thing I look at:

I cannot begin to tell you how important these numbers are–Operating Cash Flow to Profit.

So what are we measuring? We’re comparing operating cash flow to earnings/profits before taxes. In a cash business like Taco Bell or Pizza Hut, expect operating cash flow to profits to be around 100% always. That’s because inventory rarely moves and there is no AR (accounts receivable). In short, working capital just doesn’t move that much.

In a small business where owners struggle with working capital management, expect to see wild fluctuations from period to period.

That even happened to Growing Big when they dropped to 66% a few years earlier. In recent years, they have trended favorably from 85% to 91%.

Boring Company? Ouch. We need to dive into the cash flow statements to see what’s happening.

Free Cash Flow Analysis

While I’m on cash flow, I like to scan free cash flow too.

Free cash flow is defined as operating cash flow less capital expenditures. But I much prefer the Mark Gandy definition of free cash flow. Instead of subtracting all CapEx from operating cash flow, I only like to subtract maintenance CapEx which means I’m excluding large, infrequent investments in a new plant, warehouse, or something similar.

So I like to look at Free Cash Flow to Operating Cash Flow expressed as a percentage. If we have a high percentage, that means more discretionary cash flow for the owners. They can either pay down debt or pull it out of the company.

Here are the results for each entity:

Interestingly, Boring Company’s Operating Cash Flow is not being used very much to fund capital expenditures. Is that why Revenue per FTE is depressed? We’ll need to find out. My theory is that minimal CapEx means little if any technological creativity or improvement.

Notice the variation of Growing Big’s ratio. I will be curious to find out the large-ticket items they have been spending money on.

Retained Earnings

If cash flow is the lifeblood of any company, then retained earnings has to be the center of gravity of any growing business. That’s because retained earnings is the fuel for future growth. True, debt plays a role. But mature and growth-minded CEOs understand how critical retained earnings are now and down the road to not just grow but to sustain a business over the long term.

So let’s take a look at the three rows or levels of detail I study in the picture below:

In the first row, I’m just looking for one thing. Is the trend upward, downward, or sideways? Movement in Retained Earnings is a function of profits and retention of such profits.

And that leads to the third row (I skipped the second row for now). The retention rate is another one of those favorite metrics I take very seriously. Most small businesses I encounter pull way too much out their businesses relying heavily on bank debt to solve growth issues and poor stewardship of working capital.

I’m not looking for a certain retention rate. If we’re growing, I just want a nice fudge factor where the retention rate exceeds the company’s growth rate (in terms of sales).

I skipped a row–Retained Earnings to Assets. I want to know if we’re dropping. And if so, I have enough data to understand why. What I hope to see in any company is consistency with this number. If not, fasten up, the financial ride is going to be bumpy.

And That’s a Wrap For Now

So there you have it. Nothing fancy. Just the basics.

Yet, I can quickly surmise the health and the direction of a company in just a few minutes once I have the data.

I stated earlier this is a holistic approach. Well, yes and no.

I don’t know much about the company’s strategic (and off-balance sheet) assets nor the affinity it has with its customer base. Even the numbers cannot tell you about the employee morale. Is the business highly dependent on a control-oriented CEO? Are systems and processes sound? Does the company have a small monopoly or swimming with sharks in a commodity-driven sandbox?

There’s still more to learn, but this is just a starting point. And it’s a good one according to every client who signs me up as their new CFO.

See The Full Set of Visuals

Here’s the link to my Tableau Public site with all the images included in the article above.

Photo Credit: Joshua Earle

Some Fun with a Simple Flash Report

All Articles, Financials, Key Numbers, Reporting

I’ve been doing the CFO thing for roughly 16 years for small to mid-sized businesses. Along the journey, I’ve seen some fascinating sales reports over the years.

Some are so-so. Some are just really, really bad. And others? Pretty okay.

Mine? I’m not a designer. But let’s take a peek at what I did for a recent client. We’ll call this a simple case study on creating meaning with limited data. So let’s get started.

We’re Keeping It Super Simple

Retailers, grocers, and food service providers report sales, gross profit, customer counts, and average transaction size in their daily flash reports.

For this discussion, I want to keep it super simple–just sales, that’s all.

Also, I’m doing my work in Tableau as I can build visuals must faster than I can with Excel.

Finally, we’re just working with one month of sales data. I know, a bit boring. Again, the focus is on presenting reporting ideas with limited data. You’ll be able to apply the concepts with a full year, or multiple years of data.

Since my favorite restaurant is Emmet’s Kitchen & Tap located in beautiful downtown Fayette, Missouri, let’s pretend we’re helping the owner to gain insights with a recent sales month.

1. Pulling in the Data

First, I extracted the sales data for July 2016. Needless to say, this was the easy part

The very first thing I do is add totals to the table. Meh, we can do that in a spreadsheet.

2. Adding Visuals

Now we need to do something with the data. The data table does not allow us to see how we did by day of the week. So that’s the first visual I created.

Also, notice I’ve created a filter which removes Week 27. We’re assuming Emmet’s does not operate on a 4-4-5 week calendar. Week 27 only had three days, so I’m excluding. If not, several days will be skewed higher than the others.

And then Tableau makes it easy to create simple dashboards. Since the visual above excludes the sales total for the month, a simple dashboard can be included to show the monthly visual like the one below.

Sales by Week

We’ve shown sales by day, and we clearly see the weekends are our best sales days. No surprise. But let’s turn our attention to sales by week. Again, I filtered out the stub week at the beginning of the month.

Not a lot of insight, yet. I’ve added gradients emphasizing the strongest from the weakest weeks. I think we’ll find later that Week 28 dropped as it was the week right after the holiday which I’m calling the holiday hangover.

Sales by Day

So far, we have not looked at sales by day. So I’ve added it below.

Typically, we don’t use bars for run charts. But I wanted to show the second dimension for my date area. I have the actual date. And since the date didn’t mean much to me, I added weekday. And that second dimension for time forced me to use bars.

Frankly, this is meaningless. We’re comparing apples and oranges. Spotting trends are really impossible.

Oh, so you’re blaming it on the bars? Well, here’s the line chart (without the weekdays).

I even added a reference line above which is the average sales per day for July. Again, meaningless. The average is including the big days and the slower-moving days.

So we’re going to group our sales per day by day of the week. Is this better?

I’ve also added reference lines showing exceptional behavior in the data. No, it’s not a XmR or SPC chart–overkill with this limited data.

Notice the very first data point appears to be an anomaly for a Monday. It’s not as it was a holiday.

I’ve added some other markers for the owner to investigate further.

The Calendar Presentation

The chart above helps a lot. But it can still be a shade hard to follow.

When it comes to visuals of any kind, I don’t want to have to think very long. I want to able to grab the big picture immediately, and then start acting on what the data is telling me.

So I thought I’d attempt showing sales on a calendar. Below is my first attempt.

Well, it’s a start. The sales data is shaded because I’ve clicked on one date of the calendar which triggers a tooltip, and that greys out the other cells.

The calendar still doesn’t pop. We want insights, and this view is making us work way too hard.

So the last thing I did was to create a calendar heat map. Now, I get it. I can clearly see my best days on the weekends along with the weekdays.

This view and the line chart with days broken out by weekday provide insights we might have otherwise missed.

Now we can start asking questions on whether drops in certain days of the week were out of our control or not. If not, then something with our marketing needs to be addressed. For example, what happened on Sunday the 17th?

What about weekdays? The smallest part of our marketing dollars (probably 20%) yield the greatest impact on sales. We just don’t always know where. But I can bet that 20% is not helping on weekdays.

If so, we can be determining what controllable costs can be shaved during the week.

Summary

We’re merely scratching the surface, and that’s probably an exaggeration.

Hopefully, this gives you some ideas on what you can do with some of your daily, weekly, and monthly sales data when creating flash reports. Obviously, you’ll have the history where you can make comparisons to previous periods. In this exercise, I wanted to keep it simple.

When creating any flash reporting, remember this critical maxim–the goal of any data analysis is to gain meaningful insights that can be turned into actions.

In the meantime, happy flash reporting.

Photo Credit: Robert Bye

Would You Want to Be CEO for Barnes & Noble?

All Articles, Financials, Management, Strategy

I used to look forward to walking through my local Barnes & Noble in Columbia, Missouri on a weekly basis. I could browse the book shelves for hours and easily drop a hundred dollars before leaving (so much for the family budget).

In 2011 while rushing for a connecting flight with about 6 books under one arm and pulling a suitcase with another, I realized lugging books around while traveling had to go.

That’s when I bought my first Kindle device. Subsequently, I also started devouring Audible books. Since then, Barnes & Noble has lost a lot of my business.

When I drive by Barnes & Noble today, I feel as though I’m staring death in the face. Am I?

Is Barnes & Noble Salvageable?

I predict Barnes & Noble will suffer the same fate that Borders did back in 2011 when it liquidated its remaining 399 stores.

Their biggest obstacle is the web. Notice I didn’t say Amazon. If not Amazon, then Barnes & Noble would be facing a different online competitor. Barnes & Noble continues to struggle with its own online technology. Ditto for the Nook which has largely been a flop according to many business analysts.

The only thing Barnes & Noble has going for it is that it has limited debt. But that will change quickly as operating cash flow has been consumed by ongoing capital expenditures.

While the Story is Bleak, The Numbers Are Even Uglier

I couldn’t help myself. I did a little digging. These numbers are pretty darned ugly.

Still want the CEO’s job?

How Does the Fall of Barnes & Noble Impact Your Small Business?

I’ve always been a fan of Porter’s Five Forces, and I was glad to see Host Analytics CEO Dave Kellog mention this strategic mental model in a recent blog post.

Clearly, Barnes & Noble operates in an unattractive industry (brick and mortar book store) whose business is being negatively shaped by two of Porter’s Five Forces–bargaining power of buyers and threat of substitutes. And that raises a couple questions:

Bargaining power of buyers – how does Barnes & Noble recapture market share when cheaper books are a click away with free shipping elsewhere?
Can the brick and mortar behemoth survive not having a better web presence or reader device similar to Amazon? Then again, who needs a Nook when you can read books on any tablet?

Barnes & Noble is a great study of a mighty giant falling before our very eyes. Every small business owner should take note.

Just because you are experiencing great sales increases today doesn’t mean performance will last. Competition and threat of substitutes will always be lurking at your door.

One of the keys to surviving and thriving is never being complacent. Ignoring external factors can ruin your business.

In short, you need to be continually innovating. Perhaps Barnes & Noble thought it was when it introduced the Nook. Too little too late? Probably.

I wish them luck, and I hope they can do more than hang on. But they have a huge upward battle.

Leaving a Business on Your Terms

All Articles, Strategy

The term exit planning sounds so cold, so calloused, so calculating.

If I were a content writer for any exit planning expert, I’d force them to quit using this term entirely.

Business owners pour their lives into building companies at the risk of isolating themselves from family members and friends during the early turbulent years. These talented men and women put everything at stake enabling others to make a living.

In short, business owners create compelling storylines that impact the lives of others which took years to write (and to endure).

Still like the term exit planning? I prefer something a bit more personal. Let’s call it Leaving a Business on Your Terms. And “your terms” means not someone else’s terms.

Should You Hire an Expert?

For now, I’m sticking with the term Exit Planning. And yes, you need help.

No, I’m not a salesperson, and I make no money from this endorsement to recommend outside experts.

My reasoning is simple. You have written a great script, a great story in building your business. There’s a prologue followed by the dedicated to section which includes moving comments for your loved ones.

Chapter 1 is about beginnings, the origins of You, Inc. Ultimately, You, Inc. becomes Big, Inc. Or something like that.

The plot thickens as you share the high points and your most depressing moments during the scaling-up years.

As you reach the finish line, your final chapter needs an ending. As the publisher and editor of your story, you want a happy ending. But why are you staring at a blank sheet of paper or a blinking cursor on a white monitor?

And that’s what a gifted exit planner does. They help you craft the final chapter of your life as a business owner. You still make the decisions, but they are the thankless guides providing strategic calls to action that only you can act on.

In short, they help you to leave on your terms, not the terms of someone else.

When Do You Start?

The simple answer is right now. But you and I know that’s unrealistic.

How about sooner rather than later? That’s really the best answer, but it’s still vague.

You’ll know when. As long as you have a sense of self-awareness with a non-controlling mentality, you’ll know when to start the discussion with an expert. Possessiveness causes you to hold on. When you learn to let go, you’ll be ready. I guarantee it.

The wrong answer is to wait too late. Don’t do that. If so, the final chapter of your book ends in tragedy. I don’t want that. Neither do you.

What Does an Exit Planning Expert Do?

I’m not sure. I just know that when my client is ready to step away, we’re miles ahead of other business owners that are in the same boat. Since I’m a systems-driven person, I always think with the end in mind. While my clients may not know this, I’m always ready on behalf of my clients when we bring in the hired guns.

But I still didn’t answer the question.

I still don’t know. But I know this:

They ask tons of questions about what you want
They find out if you want to sell or give away the business
They address every tax aspect of any potential decision you make
There will be plenty of questions about your management team
They walk through money scenarios for any succession strategy you may consider

In short, they want to help you meet your goals for the third-most important business decision you’ll ever make. The first is getting started. The second is staying the course when everyone else says you should quit. The third most-important decision is stepping away, which is the hardest decision of all in my opinion.

Every championship team that begins training camp and then plods their way through a long and grueling regular season starts with a book. It’s called the playbook.

That’s what exit planners do. They write playbooks. They’ve written hundreds of these Xs and Os playbooks. They even have one with your name on it. They are the Vince Lombardis and the John Woodens of exit planning. They ensure that you leave on your terms.

They don’t do their work effortlessly. It just looks that way. But don’t all experts make their work look easy?

Where Do You Begin?

I would never hire an exit planning strategist without a obtaining a ringing endorsement from someone I trust. And I’d want case studies of their prior successes.

You should be able to get a short list from your accountant, attorney, or financial planner.

I normally don’t endorse professionals on my digital platform, but these names are so important, I’m gladly breaking my own rule. Accordingly, I am listing three names I’d entrust to any family member down below. Two I know well. I know the other by reputation. All three are national thought leaders in this domain space.

Should you reach out to them, they will not sell you anything. They are fact-finding junkies and will ask many questions to determine if there’s even a fit. And don’t be surprised if they drop a lot of ideas in your lap before they are ever engaged to provide exit planning services for you.

Don’t be afraid to ask questions. Learn the lay of the land in the world of exit planning, especially if this is uncharted territory in your mind.

Logistics may be an issue, maybe not. If distance is a concern, the exit planning world is small, and they will have other names to share with you that live near you.

The G3CFO Short List of Exit Planning Experts

Jane Johnson of Business Transition Academy – She’s the best. Years ago, I encouraged Jane to start building a platform in the world of exit planning. She’s amazing, intelligent, and can navigate the succession planning landmines with ease. She’s a likeable expert. We stay in touch, and I learn something new after every discussion.

Dennis Niven of B2B CFO^® – I met Dennis when I was in the same CFO firm he’s in today. I could easily say the same thing about Dennis that I said about Jane. This guy is just freaking intelligent with a great Bob Newhart sense of humor, probably better. Dennis is a great strategist like Jane is. I’m sure if you drew a Venn diagram of their capabilities and accomplishments, the circles would mostly overlap.

Barbara Taylor of Allan Taylor & Co. – I do not know Barbara on a personal level, but we’ve had a brief conversation on LinkedIn. I have enjoyed the handful of articles she has written for Forbes. And her website is packed full of great content. Plus, she’s from a neighboring state, Arkansas. Barbara is smart, capable, and strategic. Like Jane and Dennis, she knows how to help you to achieve your goals and dreams for your next season of life.

The Call to Action

It’s your book. Your story. Your beginning. Your middle. Your end.

Do it on your terms. You get to write the final chapter. The epilogue too.

Just don’t do this alone.

Endorsement Disclaimer

I’m not paid by the great people I recommend. It’s just that my conscience dictates that I need to let you know that Mr. Niven is a very giving man as validated by the gift he sent me in 2011 (the same year the St. Louis Cardinals won the World Series).

So not only is he smart, he has a great taste for gifts too. Dennis, thank you (for about the hundredth time)!

Title Photo Credit: Daniel McCullough

You Had a Great Sales Month, So What!

All Articles, Financials, Management

Periodically, I get a call or email from a client early in the month stating something like, “Hey Mark, we had an awesome month. What do you think?”

CEOs love sales. Heck, CFOs probably love sales even more. But I still hate these messages unless I know the plan calls for increases on the top line.

I used to ask, “Why the increase?” The typical response was, “Well, I’m not sure. We just had a good month.” When I get that feedback, then I can rest assured that the sales increase is merely random.

So I quit asking.

No, I’m not trying to rain on anyone’s party. But stay with me–you need to be able to answer the “why” behind your sales increase. There might be a compelling story, maybe not.

My Restaurant Sales Were Up 7.1 Percent Last Month

Let’s start at the top. See if this discussion resonates between a restaurant owner and his CFO.

CFO: Was the sales increase planned?

CEO: What’s a plan? We don’t do that around here.

CFO: Okay. Then what drove the sales increase?

CEO: What do you mean? I just watch the dollars. We were up more than 7%. What’s wrong with that? I think my store is looking up.

CFO: Well, maybe. Have you looked at your covers (transactions) month by month? How about average ticket?

CEO: Hey, you ask a lot of questions. I need my accountant to look into that.

Thankfully, the CEOs I serve are not this simple minded. If so, then God help me.

But the above dialogue is a good springboard as to how we should look at our top-line sales.

You Don’t Need to Be a Brain Surgeon to Understand the Math

I’ve always wondered what occupation a brain surgeon uses when explaining a complicated concept. Rocket scientist?

Sorry, I digress.

Let’s start with the most fundamental sales analysis I can think of–I use it for all of my clients. Don’t worry, the math is easy.

Below is a simple sales variance analysis where we isolate on transactions, average ticket, and sales (while the numbers are small for this one-store restaurant operation, the concept applies to any transaction-based company).

Remember, our CEO has stated sales are up more than 7% in the prior month ($128,721 vs. $120,141). You will find those numbers right above the totals.

But what do you notice? Here are my overall observations at a high level:

That prior month increase appears random (more on this later)
For the last 12 months, sales are only up about $30,000
But not because of transactions–those are down 855
We’re up because the average ticket increased from $12.85 to $13.20

What do you think so far? Is this much better? Does this provide deeper insight to our top line?

I’m not done. I’m just getting started.

Every Small Business Should Be Analyzing Sales Using Simple Unit-Rate Variance Analysis

In the snapshot above, I’m referring to that table as a simple variance analysis. The emphasis is on simple.

I’m too lazy to pull out my old cost accounting textbook, but I think we call the table below a unit-rate variance analysis.

My friend Rand Heer of Alight Planning calls the snapshot causal analysis. He’s a smart dude, but the average Joe doesn’t recognize that term. So I’m sticking to unit-rate variance analysis as shown below:

The second snapshot is similar, yet different from the first. The primary difference is reflected in the Unit/Rate Variance columns. For convenience, I’ve added the monthly percentage sales increase at the far right.

So let’s see what we can glean from this table:

Sales are down overall by nearly $30,000 (see bottom, far right, last row)
The dollar impact of guest transactions being down by 855 is $10,931
The dollar impact of the average ticket increasing to $13.20 is $40,623

Now we have a better understanding of why sales are up overall the past year. It’s not the number of transactions which are down.

We can clearly see that the average ticket increase is driving sales upward. We saw that in the simple variance analysis. But in this table, we know the actual sales impact by dollars. And that’s important.

The beauty of the unit-rate variance analysis is that we can measure the dollar impact of transactions and average ticket sizes being either up or down.

More importantly, we now have insight as to what we need to work on–getting more butts in seats. Without this insight, the owner might be content with an overall store increase of 2%.

On Deck, Trend Analysis

I’m just warming up.

Remember, our CEO said, “I think my store is looking up.” The CEO said this in light of a good month.

Not so fast. Let’s look at the last 24 months of sales and see what we can learn.

I’ve included 4 pieces of data.

The small dots represent actual sales by month. The solid line in the middle is the average over the past 24 months.

The dotted lines are approximately 3 sigma above and below the central line–we call these upper and lower limits.

Here’s the main thing you need to know about these charts–most data fall within the upper and lower limits unless there’s been a significant change in a process or behavior that would impact these limits.

Accordingly, any changes from month to month are merely random from a statistical point of view. So that 7.1% increase the prior month is just noise in a sea of other data points.

Transactions (Guest) X Chart

Let’s see what the chart looks like for number of transactions.

My primary observation is that there’s minimal variation with our transactions. But we need to keep an eye on the data as we did see a one-year drop of 855 transactions which negatively impacted sales by nearly $11,000.

Many small business owners focus on the dollars only. Do that and you are shooting yourself in the foot. Customer and transaction churn is a deadly cancer in any business that desires to stay alive in the long term.

Are you monitoring your customer/client sales transactions similarly to what we’ve covered so far?

Average Ticket X Chart

Finally, let’s look at the trend for the average ticket size. My Excel template automatically repainted the average line as the prior eight periods were above the original calculated average–that run (or streak) triggered the increase in the average and the upper and lower limits.

The underlying causes pushing data upward in this case do not happen by accident.

About a year ago, I found out the owner finally increased menu prices across the board due to increases in commodities like dairy products, poultry, seafood, and a few other categories.

The owner conducted training on upsales with its dining crew. It’s no wonder the central tendency and the limits moved northward.

What about the $13.78 in the previous month? It’s within the upper and lower limits. Still, it’s getting close to an outlier.

In my discussion with the owner, there were some specials on the menu on a one-time basis at higher pricing. Unfortunately, the promotion had no impact on getting butts in seats. And the one-time large increase will not be recurring.

“I think my store is looking up,” said our CEO earlier. Based on what you have learned, what would you say to her?

The Purpose of Data

Data can be so darned insensitive at times. It should. Data has no personality.

But you do. And you have full control to behave in ways that will shape this data to your liking. The data merely tells whether your behaviors and actions are working or not.

Remember the famous line in Glengarry Glen Ross? “Always be closing.”

Similarly, you should always be innovating. Always be getting butts in seats. Always doing what it takes to make sales increases recurring.

And that’s why it’s critical not to just look at top-line sales in isolation or even a month’s worth of data compared to a prior period.

I leave you with a $64,000 question. The next time you have a great sales month, what will you say to your CFO?

We Need Wins Above Replacement (WAR) in Small Business

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I confess that I’m a little fanatical about baseball statistics. And yes, sometimes these numbers cross my mind when I’m thinking about senior management team members.

Take wins above replacement (WAR) for example. Let’s say my number is 8.4 as a shortstop for the St. Louis Cardinals. That number means I’m responsible for about 8-plus wins over a replacement player who could be acquired at a minimal cost with minimal effort at my position.

Wouldn’t it be great if every person in LinkedIn had a replacement value that could be quantified next to all of his/her titles throughout the years? I know, it’s preposterous, but it’s fun to think about.

Other Names for WAR in Small Business

Let’s pick a few positions in business and come up with a similar metric.

Sales Rep | Sales Above Replacement – This number would have to be industry specific. Let’s say a rep works in the retail car industry. A Sales Above Replacement (SAR) of 8.2 would mean that rep sells on average 8-plus more cars per month than a replacement that could be acquired at minimal cost or effort.

Marketing VP | Market Share Above Replacement – Great marketing teams attract new buyers to the organization. One of the goals of marketing should be increased market share. Accordingly a Market Share Above Replacement (MSAR) of 9% means this VP can obtain an extra 9 percentage points of market share over his/her replacement acquired at a minimal cost and effort.

Get the idea? Let’s do one more.

Merchandising Manager | Really Good Deals Above Replacement – I admit, I’m pushing the envelope a bit, but let’s say a particular eCommerce company has a way of measuring a great buy yielding a better-than-average margin that will turn quickly. That’s a great deal. A Really Good Deal(s) Above Replacement (RGDAR) of 33 means this person will generate 33 great deals annually over a replacement who could be acquired at minimal cost and effort.

Go down each position in your company, and I bet you can come up with your own key measures like the WAR metric in baseball. All you need to determine is the following:

Name the position.
List what the greatest requirement, objective, or desired result is.
Note what the minimal output is for someone that is average.
Then track the number and be transparent with the number.

Imagine if Every Senior Team Member Had a WAR-Like Measure

The COO. The CMO. The CFO. Even the CEO himself.

Better yet, what if the team had a WAR-like measure?

Here are some ideas, and some of these have already been mentioned:

Sales above replacement (of a leadership/management team that could be obtained at minimal cost and effort)
Customer satisfaction above replacement
Market share above replacement
Profit above replacement
Return on assets and equity above replacement
Return on overall business value above replacement

Do You Work for the CEO? You Need to Ask These Questions Regularly

The more I think about this topic, the less crazy it seems. And if I’m an employee of the company, either as a staffer or a senior management team member, here are 3 questions I want you to address regularly:

Am I making a difference? How have I contributed to increase sales, profits, market share, customer satisfaction, and return on assets this past year?
Would I truly be missed if I left the organization? Would my replacement be more or less productive? By how much?
When I’m at the office, do I spend more time thinking about myself or the organization?

Shut the door, pull out a pad of paper, flip on Bach’s Air on G String, and start writing. Be honest too.

Want to up your game? Share your results with your peers and decide right now how you are going to improve.

Are You the Owner? I Have a Few Questions for You Too

Now I’m convinced this is a great idea.

The key is making sure you have quantifiable requirements for each role as well as each team in the organization.

Name just three numbers each team member reporting to you should hit at a minimum.
Repeat the process for the team that works for/with you.
For each person and the team, what incremental increase would you require in a replacement or for a brand new position?

Sorry, I have a few more, but I’m saving those bullets for clients of G3CFO. But the three above are enough for now.

Why did I have to step through this process for both individuals and the team? The key word is synergy.

I love great baseball, and I enjoy watching the St. Louis Cardinals. If you ever catch a season opener, you will be impressed with the mighty Clydesdales galloping around the parameter of the field.

The average Clydesdale can pull 7,000 to 8,000 pounds. You would think two would pull twice that amount. Try again. Two can pull about three times the amount of just one Clydesdale. And that’s called synergy.

Your VP of Sales should have a sales above replacement of $10 million, maybe more. But your team as a whole should have sales above replacement of perhaps 2x or 3x, right?

Theoretical? Maybe, but so is Wins Above Replacement too, as not all baseball purists trust the number.

But you have to admit the concept is intriguing. If nothing else, don’t take incremental improvements lightly or accept the status quo each year. You need to expect more from each individual along with the team. But don’t worry. Your best team members will be agreeing with you.

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