The Key Metrics You're Not Watching, But Should Be!

But how would one know that they are making more money? Through measurements.

There are three measurements that actually tell you whether you are making money or not: Profit Margin, ROI, and Cash Flow. Each of these metrics plays a crucial role in assessing the health of your business:

1. Profit Margin: This measures what your company retains as profit for every dollar of sales after all expenses are covered. It’s a direct indicator of your operational efficiency and pricing strategies.

2. ROI (Return on Investment): This gauges how effectively your investments are generating returns. A high ROI means that the investments made in the business, from equipment to marketing campaigns, are paying off.

3. Cash Flow: This tracks the inflow and outflow of cash, ensuring that your business can maintain its operations and grow. Cash flow is fundamental to the survival of any business because, without sufficient cash on hand, even a profitable business can find itself unable to meet its immediate financial obligations.

Learn more about how to calculate these metrics, and why they serve as a critical indicator of your business's operational efficiency. 

Why All Three Metrics Matter Simultaneously

It’s possible for a company to show a net profit and a good ROI and still face financial jeopardy. For example, a company might display robust profitability and return on investments, but if it runs out of cash due to poor cash flow management, it can quickly go under.
This is because when cash flow is positive and sufficient, it might seem like a non-issue, but if it becomes negative, nothing else may be able to save the company. Thus, the key is to ensure all three metrics—Profit Margin, ROI, and Cash Flow—are healthy and improving simultaneously.

While those indicators are crucial for upper management to assess the company’s financial status, they often don't resonate with teams who aren't in direct contact with fiscal details. Meaning we need to find the bridge, the correlation that connects between high-level financial metrics and the day-to-day activities managed by lower-level management.
Here’s how this can be achieved through practical, relatable metrics: 

• Throughput: The rate at which the system generates money through sales, not through production. (The money that is coming in)

• Inventory: All the money that the system has invested in purchasing things that it intends to sell. (The money that is currently inside the system)

• Operational Expenses: All the money the system spends to turn inventory into throughput. (The money you have to pay out to make throughput happen) 

Having defined the crucial metrics of Throughput, Inventory, and Operational Expenses, let's take a few practical examples of specific metrics that companies can adopt to ensure these foundational measures are not just theoretical but actively monitored and optimized. 

Throughput

Throughput, as defined earlier, is the money generated through sales. This is a critical metric for all departments to focus on, as it directly relates to the bottom line.

• Technology Company Example: A tech company might measure throughput by tracking the monthly sales of software licenses and cloud storage solutions. By monitoring trends in these sales, they can identify which products are performing well and which may require additional marketing or development resources.

• Industrial Plant Example: An industrial plant can measure throughput by the volume of units sold monthly, such as automotive parts or electronic components. Tracking these sales helps pinpoint production efficiency and market demand alignment, allowing for adjustments in production schedules and inventory management.

Inventory

Inventory involves all capital tied up in goods intended for sale, reflecting the potential to generate revenue.

• Technology Company Example: For a tech firm, inventory metrics might include the development cost of new software awaiting release. Keeping track of development expenses against projected sales can help in forecasting ROI and adjusting project timelines or budgets accordingly.

• Industrial Plant Example: An industrial plant should monitor both raw materials and finished goods. Measuring the turnover rate of these items, coupled with their carrying costs, provides insights into how well the plant manages its resources and how quickly it can convert investments into salable goods.

Operational Expenses

Operational expenses encompass all costs incurred to convert inventory into throughput. Efficient management of these expenses can significantly impact profitability.

• Technology Company Example: In a technology company, operational expenses might include server costs, bandwidth expenses, and technical support salaries. Monitoring these costs against the throughput generated can help in identifying areas where efficiency improvements could lead to cost savings.

• Industrial Plant Example: For an industrial plant, operational expenses would include the cost of machinery operation, labor wages, and maintenance expenses. Regular analysis of these costs as a function of throughput (sales revenue) helps in optimizing production processes and reducing waste.

The metrics outlined above are just a few examples of the detailed measurements that companies can incorporate into their evaluations of Throughput, Inventory, and Operational Expenses. Each organization should consider these examples as starting points and customize its own set of metrics based on specific industry demands, operational nuances, and strategic objectives. 

To ensure these metrics resonate with all staff, make sure to integrate them into regular reporting and communication strategies.
For example, monthly meetings could be used to discuss these metrics in the context of overall business performance. Dashboards accessible to all teams can display real-time data on these metrics, helping staff see the immediate impact of their efforts on the company's financial health. Educating all employees about how these metrics impact the company's success and their roles can empower them to make better decisions that align with corporate financial goals. Workshops or training sessions on financial literacy tailored to specific department needs can bridge the gap between high-level financial outcomes and day-to-day activities. However, it's equally important to be cautious—metrics can sometimes be misleading if not analyzed correctly. To learn more about how metrics might lead you astray, check out our article Can Your Metrics Deceive You into Making Bad Decisions? which delves into common pitfalls and how to avoid them. 

By aligning operational metrics with key financial goals, companies ensure that every team member—not just those in finance—understands how their actions contribute to the organization's success. This holistic approach not only enhances operational efficiency but also fosters a culture of accountability and shared responsibility for the company’s financial performance.

Understanding and implementing the right measurements to map productivity effectively can be challenging.
Here is an additional interesting article you might be interested in reading: get-better-at-figuring-out-how-to-manage-your-resources

Recommended Reading: To further explore how aligning your organization’s efforts with its primary goal can dramatically improve performance, I suggest The Goal by Eliyahu M. Goldratt. This book is a powerful guide on how to identify and eliminate the bottlenecks that hinder your business's profitability.

Looking to take it a step further? If you're ready to define and align these critical metrics within your organization to enhance both operational efficiency and financial health, we're here to help. Let’s work together to turn these concepts into actionable strategies that drive real results.