Last month I gave a brief prelude to Step 7 and mentioned a "dashboard" that contains the relatively few key measures that managers of A&D firms should monitor like a North Korean launch pad.
The problem is, if I asked you or your accountant to name the crucial measurements that drive your future business success, few would come up with the ones I believe are truly essential.
Speaking of your accountant, many of the problems with attempting to derive meaningful measures originate because most of what accountants do for small businesses is largely worthless.
There, I've said it. I've been aching to say it for 20 years. But please notice I didn't say accountants are worthless. Most are bright people who mean well, but what they typically do for small firms, that is, the process of accounting, is mostly a big waste of time and money.
By definition, accounting is an ancient system designed to store historical financial data and produce summary reports that are supposedly invaluable. But in school, almost all accountants are fed a steady diet of principles geared toward Fortune 500 and other public companies. Because the burden for full disclosure is so much higher for public companies, certain standards are adopted, such as:
- Standard financial reports: such as income statements, balance sheets and cash flow reports. These reports are required by various entities including banks, shareholders and the Securities Exchange Commission.
- Accrual-based accounting: creates such artifices as "income" and "expenses" and (to the small business owner's great detriment) detaches itself from the all-important role of cash. Accrued books are supposed to smooth out the timing of investments, receipts, etc., giving a fairer view of operations over time.
So, naturally, this is the training that accountants tend to bring to small businesses. To prove this, I simply ask whether or not your accountant has ever suggested (or pleaded) that you produce monthly financial statements, and whether he or she ever suggested using accrual-based accounting to do so.
I thought so.
And what happened next?
The accountant probably sent in a bookkeeper (talking about the great savings of bringing in someone at a lower hourly rate) to set up your "chart of accounts" within the general ledger. You nodded with appropriate disinterest. Given this level of disinterest, you didn't really get involved in how those accounts were coded, meaning the statements that were ultimately produced were almost certainly worthless (see Step 2 in the March issue of I&S).
For example, you might want to someday see what percentage of your payroll was going to residential versus commercial projects, or what percentage of your marketing budget was going to direct mail versus advertising.
Sorry. If you didn't think of all that back in the days of disinterest (when your system was first being set up) it's too late now. So you get a set of financial statements that not only fail to provide the detail you need, but are based on accrual accounting, meaning that the only way for you to determine whether you can afford to pay the bills is to throw those statements away and go check your bank balance.
As for trends, small businesses don't grow by 4 percent or 6 percent a year like many giant public companies do. They can't predict their earnings each quarter to the penny. In fact, small businesses routinely grow by 30 percent, 100 percent or more … and then can shrink by the same amount the next year as they are often subjected to many unpredictable factors. In other words, for the small business, comparing month-to-month and year-to-year trends of traditional financial statement data provides almost no information worth setting up a system to track. Moreover, the accrued numbers cause us to take our eyes off the only thing that really matters—cash.
But, if we're tracking the wrong things through our accounting systems, what are the right things and how do we track them?
I have identified eight separate profitable design models, and here are some of the key success factors we typically track:
- Revenue per employee
- Time billings and product billings as percent of total billings
- Cash on hand to total fixed costs
- SDCF to total sales (SDCF is seller's discretionary cash flow)
And there are many more,which is why I have created a "Designer Dashboard™" for members of my Best Practices Network. Here, in one page of charts and graphs, one can see where they're going, not where they've been. We like to focus on the future, not the past—on leading indicators, not historical data.
Next month will be the final segment of the "8 Steps Challenge" and, like a good novel, I've saved the best for last. Don't miss Step 8, which will show you how to change your business—and your life!
David Shepherd is president of Designing Profits Inc., a firm focused on the financial success of design professionals. For more information, visit www.designingprofits.com.