Most business owners get a profit and loss statement every month, quarter, or year. It contains a lot of numbers, but that doesn’t necessarily mean it contains the numbers that are most useful for running their business.
I’ve been spending a lot of time lately helping my clients identify what I call their critical numbers. These are the handful of measurements that tell us where the business is doing well, where it may be struggling, and, most importantly, where we may be able to do something about it.
Those numbers are different for every business.
For one client, we may be watching labor as a percentage of revenue. For another, we’re looking closely at the profitability of individual jobs. Another may be growing quickly enough that our biggest question isn’t whether there is enough work coming in, but whether there is enough capacity to take it on.
That’s the difference between having financial reports and actually using them.
What makes a number “critical”?
Revenue matters. Profit matters. Cash in the bank certainly matters. But that doesn’t make every number on your financial statements a critical number.
A critical number is something we can measure consistently that tells us something useful about the health of the business. Usually, it points to a strength we want to build on, a weakness we need to address, or an opportunity we don’t want to miss.
It also needs context. Knowing that payroll was $25,000 last quarter doesn’t tell me very much by itself. If revenue was $50,000, that payroll number tells one story. If revenue was $100,000, it tells a very different one.
That’s why percentages and trends are often more useful than the raw numbers themselves. Looking at expenses as a percentage of revenue allows us to compare one quarter to another even as the business grows. It can also make changes much easier to spot.
The goal isn’t to find more numbers to track. Most business owners already have plenty of those.
The goal is to figure out which numbers deserve your attention.
Sometimes the number is labor
For many service businesses, labor is one of the largest costs of doing business. That makes labor margin particularly useful to watch.
If revenue is growing but labor is consuming an increasingly large percentage of it, we need to know why.
Maybe wages have increased and prices haven’t. Maybe jobs are taking longer to complete. Maybe overtime is creeping up. Maybe scheduling has become inefficient. Or maybe the company is simply doing more of a service that doesn’t carry a strong enough margin.
The labor percentage doesn’t answer those questions for us, but it tells us which questions we need to ask.
That’s an important distinction.
I don’t want my clients to receive a P&L that says payroll increased by $18,000 and stop there. I want us to understand whether that increase makes sense in relation to the growth of the business and, if it doesn’t, what we can change.
Sometimes it’s job profitability
This is a big one for contractors and other project-based businesses.
A job can bring in a lot of money and still not be a particularly good job.
Once we properly account for labor, materials, subcontractors and other direct costs, we can start comparing the profitability of different jobs or types of work. That can lead to some interesting discoveries.
Maybe the service you’ve been pushing hardest has a lower margin than the work you’ve barely been marketing. Maybe one type of project routinely runs over its estimated labor hours. Maybe a customer who generates a lot of revenue also requires so much additional time that the relationship isn’t nearly as profitable as it appears.
This is one reason accurate bookkeeping matters so much. Before we can make strategic decisions from the numbers, we need to be confident that the underlying information is right. That foundation is a major part of the bookkeeping and accounting work we do at Serenity Solutions.
It’s also why the numbers worth watching vary so much by industry. A contractor managing project costs has different needs than a nonprofit managing restricted funds or a real estate business managing multiple revenue streams. Our Industries Served page goes into some of those differences.
Sometimes growth itself is what we need to measure
More sales are good — until you don’t have enough people, time or equipment to deliver what you’ve sold.
That’s why I’ve also been paying attention to capacity and growth pipelines.
If a company currently has enough staff to perform 100 jobs per month and is already doing 95, a strong sales pipeline means something very different than it would if the company were only operating at 60% of capacity.
That information helps us start talking about hiring before everyone is completely overwhelmed.
It can also work the other way. If a business has added employees or equipment and has significant unused capacity, we may need to focus on the sales pipeline rather than adding any more overhead.
Neither of those answers comes from looking at revenue alone.
New service lines deserve their own attention
When a business adds a new product or service, I don’t want to wait until the end of the year to decide whether it worked.
We can track it.
How much revenue is it producing? What does it cost to deliver? How much labor does it require? Is demand growing? Is it taking resources away from something more profitable?
Sometimes the answer will be, “This is working. Let’s do more of it.”
Sometimes it will be, “The demand is there, but we need to change the pricing.”
And sometimes the numbers will tell us that an idea simply isn’t working as well as we hoped.
That isn’t failure. That’s useful information received early enough to do something with it.
Taxes can be a critical number, too
One of my least favorite financial strategies is finding out what you owe when the tax return is prepared.
Tax returns are important, but they’re historical. By the time the return is prepared, most of the decisions that created that result have already been made.
With current books, we can watch profitability throughout the year and periodically estimate where tax liability may be heading. That gives the business owner time to prepare instead of discovering a large obligation after the fact.
This is part of a broader issue I see frequently: compliance and financial management work much better when they happen throughout the year instead of being treated as an annual event.
I touched on that same idea recently in 5 Things I Learned at the Missouri Chamber Women in Leadership Conference. One of the things I continue coming back to in my own business is how much better decisions become when we have useful information before we need to make them.
And sometimes the problem isn’t profit at all
A business can be profitable and still be short on cash.
That happens because your P&L and your bank account are measuring different things.
You may have earned the revenue but not collected it yet. You may have debt payments coming out of the bank that don’t appear entirely as expenses on the P&L. You may need to hold money for payroll, sales tax or estimated taxes. You may simply have a timing problem between when customers pay and when bills are due.
That’s why cash flow may become one of the critical areas we watch.
I’ve written about this before in Cash Flow Management 101: Tips for Keeping Your Business Financially Healthy, because managing cash isn’t the same thing as simply making a profit. Your receivables, upcoming bills and timing all matter. You can find that article and the rest of our financial resources on the Serenity Solutions blog.
Your critical numbers can change
This may be my favorite part of the whole concept.
The number we need to focus on today may not be the number we need to focus on six months from now.
Maybe we identify a labor-margin problem this quarter. We make some changes to pricing, scheduling or processes, and over the next couple of quarters the margin improves.
Great. We don’t need to stare at that problem forever.
Now maybe capacity is becoming an issue because the company has grown. Or receivables are starting to stretch out. Or the company has launched a new service and we need to know whether it’s actually profitable.
The business changes, so the questions we ask of the numbers should change with it.
This is why I started making quarterly one-pagers
I started putting together a simple quarterly financial snapshot for some of my clients because I wanted them to be able to see their business, not just receive reports about it.
The standard financial statements are still there. They’re important, and I absolutely want my clients to have them.
But the one-pager is different.
It gives us a place to pull out the handful of things that actually deserve attention that quarter. We can identify what has improved, what has slipped, where there may be an opportunity, and what we want to watch over the next few months.
And the response to these has been fantastic.
It turns a conversation about financial statements into a conversation about the business.
That’s really the point.
Accurate books are the beginning, not the end
I love clean books. I love a reconciled balance sheet. I love tracking down the weird transaction that has been sitting in the wrong account for eight months probably more than any normal human being should.
But that isn’t where I want the value of bookkeeping to end.
Good bookkeeping gives us reliable information. Once we have that information, we can start using it to make better decisions.
That has always been part of the philosophy behind Serenity Solutions. As I explain on our About page, my goal isn’t simply to keep a client’s books clean. I want business owners to understand their finances well enough to make smarter decisions and grow with confidence.
So the next time you look at your P&L, don’t just look at the bottom line.
Ask yourself:
What are the three or four numbers that would tell me the most about my business right now?
Maybe it’s labor margin. Maybe it’s job profitability. Maybe it’s capacity, receivables, cash flow, tax liability or the profitability of a new service.
Whatever those numbers are, identify them. Track them. Put them somewhere you’ll actually see them.
Because having numbers is useful.
Knowing which ones matter is where things start getting interesting.