Leading Financial Indicators

Financial statements for most business owners have been presented in a manner that provides a historical snapshot of a business’ perspective. A perspective that normally validates the business owners and/or an executive team’s expectations of the financial statements with little understanding or insight in why financial performance ended up the way it is certainly gives minimal information or insight into future business performance.

Valuable financial statements certainly need to chronicle and memorialize historic events, especially significant departures from the norm. They also need to provide insight into how the numbers occurred and what they will do in the future.

The evolution of financial statements from just being a report card on decisions to a decision-making tool resides in a deep understanding of how the business makes money. For example, a service oriented business’ financial statements should include utilization and effective bill rate reporting as a leading indicator to predict Gross Profit Margin. Such analysis should be done by client and by employee level to give management a clear understanding of what is working and why. This type of indicator give the business tools to adjust bill rates or employee compensation challenges based on data rather than gut feel. Instead of management teams starting discussions with the questions of what happened or what should we do, discussions focus on specific actionable items that are measurable, objective, and have a defined corrective course of action.

The initial step to developing financial statements that include leading financial indicators is to forecast future Profit & Loss, Balance Sheet items, and Cash Flows. A defined business model with variable inputs and realistic projections are critical. Once completed, a total review of the marketing, sales, fulfillment, administration, pricing model, compensation models, and accounting functions will yield metrics and benchmarks for your business. Those identified metrics and benchmarks should be integrated into financial statement reporting.

A few typical Financial Indicators include:

  1. Utilization and effective bill rates that lead into Gross Margin analysis by employee and by client.
  2. Gross Margin by product type or business line.
  3. Inventory Turnover Ratios by location and product.
  4. Efficiency ratios for businesses performing project or fixed fee type operations.

The bottom line is that financial statements should be more than a score card. The addition of a managerial accountant or the performance of managerial/financial accounting is a critical component to any executive team and yields a deeper understanding of the business. By empowering executives and managers with great financial data, a business can dramatically improve profits and performance.

Written by:
Andrew Ruff
TGG Accounting

One Response to Leading Financial Indicators

  1. […] From a more traditional financial perspective, a reader of financial statements can think of an Income Statement as a leading indicator of future cash.  Admittedly, this is a simplistic perspective of the Income Statement and discounts planned investments, but at the end of the day, Net Income is a prerequisite for long term sustainable cash balances. The TGG Way has numerous Blog Posts dedicated to the subject of driving Net Income. […]