|Posted by Percy A Lowe on July 16, 2013 at 5:30 AM|
by Frank Coker
Understanding your financial performance as a collection of trend lines changes everything. The invisible will come to light.
I am just returning from a couple of days of presentations at the Tech Data conference in Orlando. I was sponsored by CompTIA to present sessions on finance and business management. As always, I find ways to highlight the many benefits of understanding financial data in terms of trend lines. This can be a challenge because most people think they are already doing this, and it’s nothing new.
I often start by saying that financial management similar to steering a car. It’s important to observe and adjust on a constant basis. It takes constant monitoring. To make steering adjustments every 5 minutes, and closing your eyes in between just doesn’t work. Bad things will happen when you aren’t looking. In finance, course adjustments need to be made every month at a minimum or things can get off track and cause serious damage. To do monitoring and analysis, you need to compute trends every month on a rolling 24 month basis. Then look at both long-term trends and short-term trends (“leading indicators”) to see how they are working together and where conflicts lie. This needs to be done for all major account categories and for all LOBs.
However, it is very difficult to make the leap from traditional financial statements to trend line analysis. It is especially confusing when a financial manager says “we graph our data and are able to see exactly what is happening in our business.” Even if the person knows how to create a linear regression trend line, if the time frames are not sufficient to smooth out periodic spikes, the results can be misleading. And while graphs of actual performance show patterns of performance, they are not helpful to understanding more subtle questions about how various account categories are working together – for good or ill. A graph of actual performance can certainly give you a sense as to whether business is improving or not, but you won’t get a metric that will help you understand direction and trajectory. For example, it is unlikely that a graph of actual performance would help you see that your COGS payroll is growing just a few percentage points faster than revenue which means that your pricing is not keeping up with cost increases. Basic graphs just don’t tell the subtle story that determines whether a company is building earnings over the long term.
So as I discuss the basics most people usually acknowledge that they really aren’t doing trend analysis. Most people acknowledge that it would take way too long, the math is a bit crazy-complex and their data is not set up to make this practical. Typical estimates are that it would take 4 to 12 hours to do this by hand each month assuming they had an organized process in place. Of course I always mention that it takes Corelytics 14 seconds to do the analysis of 3 years of historical data and create high-probability 12 month forecasts of future performance. But I don’t want to sound like a sales guy, so I tread lightly. Besides, these are educational presentations and it is important not to stray.
Several people commented after the presentations that the discussion gave them a whole new way to understand their business. It’s always gratifying when the light bulb comes on. It just makes more sense when you look at your trend lines to see if they are either working together to strengthen the business or are in conflict and need to be adjusted.
In the world of trend analysis, it is important to understand how trends move in concert. For instance, if revenue is trending up by 15% over the long term and expenses are trending up by 17%, you can easily see that you have a problem. Just looking at static numbers or traditional graphs would probably not show this subtle difference. But this difference can wipe out profits and shut a company down in the long term.
The cool thing about trends is that you can see problems coming early. It is far less expensive to make small adjustments early rather than big knee jerk reactions when the problem is discovered late in the game. Unfortunately most business owners do not take the time to dig in to see problems early on – especially if they need to crank a lot of calculations that can lack the right precision. A simple 5% error can erase all profit.
But wait, there’s more! (Am I sounding like a sales guy?) In my next blog I will discuss an important “best practice” in using trends lines to see precisely where the greatest problems are and where your best business results are coming from. And this can be done with minimal additional time investment and at a level that traditional reports and graphs cannot do.
Categories: Small Business Managment