Part 2: Better analytics in action: clients, cash flow and capital
Written by Keir Thomas-Bryant
In part one of this guide we looked at how traditional performance metrics may be hindering a business, preventing it from reaching its full potential. In this section we give examples of the types of performance metrics you could be using to complement your traditional KPIs.
In simple terms, it’s time for businesses to stop being of the mentality where they anticipate fighting fires all the time–and it’s time they gained the insight into their business so that fires aren’t allowed to start in the first place.
Indicative, proactive and granular performance metrics can be harnessed to complement the traditional financial performance metrics your company may be using. The metrics allow a business to determine whether or not it is on track to hit its overall financial goals–and allow the business to put remediation plans in place in case it is not.
These types of metrics we look at are client retention, cash flow, and working capital.
Identify which clients should get most of your attention based on the ones you perceive are the most likely to churn.
Clients are the primary source of company revenue. And, in the age of the customer, every business should have certain client metrics as part of their key performance indicators. These metrics can signal client behaviour, which means they’re often indicators of revenue performance and cashflow.
Client churn is an important business performance metric, and it can signal contraction. The full cost of client churn includes both lost revenue and the marketing costs involved with replacing those clients with new ones. Surveying clients for NPS or customer satisfaction is important, but suffer from the issues of traditional performance metrics discussed in part one of this guide – often the results come in long after the opportunity has passed to resolve a potential issue.
Do you know which clients may be at risk of churn? How do you focus on client retention? Here are some proactive performance indicators you should consider:
- Identify your top tier clientsThis can be done by analysing client revenue, client lifetime value, or client 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, clients with the highest lifetime value may not be generating the most revenue this year/month/week, but their loyalty may be an important fact in your year-on-year growth, or contribute to other factors like brand awareness
- Analyse indicative, proactive metricsLook at current aspects of their behaviour such as:
- Percentage of projects at risk.
- Average project overrun in terms of days.
- Percentage of work not invoiced.
- Percentage of invoices that were received but rejected.
- Date of last contact.
- Action what you discoverIdentify which clients should get most of your attention based on the ones you perceive are the most likely to churn. Is there a client project you should reprioritise or an order you should place to keep a client on-track? Share the data with your customer teams and regroup to build action plans to alter the way you’re currently serving these clients and deliver the experience your team has promised to the client.
- Drive these insights into the organisationInstitute changes in the organisation to reduce risk of retention going forward. This can be done by further segmenting clients into groups within your accounting software, or perhaps, by industry or product. With data-driven insights, you’ll know which clients are at risk of attrition, often a huge unknown, and devote time with your team and that client to get the relationship back on track. You’ll also gain insight into what projects are underway, and which team members are involved in serving a particular client. With all of this client data throughout the client lifecycle – from opportunity to project completion to receiving payment – you’ll be able to spot potential issues before they become a reality.
It’s a sobering thought that most businesses fail due to issues surrounding cash flow. In fact, research suggests that a high percentage of small to medium-sized businesses fail due to poor cash flow management, and a lack of understanding of how to effectively manage it within a business.
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 metricsYou might choose to measure the following:
- Revenue from jobs in progress and revenue from jobs not yet started. Assuming the clients 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 actually 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 days inventory outstanding metric.
- Build scenarios for how your cash flow will be impactedEvaluate how accounts receivable, and ultimately your cash account, could be improved by upcoming invoices and the payment terms for clients. The more you can leverage historical and trend data to influence your predictions, the better.
- Action these insightsIf you have a large potential amount of revenue from jobs in progress then perhaps you should reprioritise 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 pipeline.
Cash flow can also be increased 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 important 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 clients pay? How slow are your slowest paying clients? What is the average days to pay across all clients? How many days in A/R are your invoices— segmented by project type?
Improving your working capital can be achieved by optimising 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 optimise 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.
Here are some steps you can follow to identify, and mitigate potential issues resulting from poor working capital.
- Measure indicative, proactive metricsYou might choose to measure the following:
- 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 clients pay once they’ve 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 client. This is often calculated according to a company’s payment terms and how a sale is confirmed.
- Diagnose issuesSet 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’re seeing payment in 45 days you’re doing pretty well.Analyse trends in your performance. For example, is it a certain group of clients 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 informationYou 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 clients so that you’re in a better position to optimise working capital and in a better cash position.