Learn how to figure out your company's critical numbers -- and how to use them to build a stronger company.
What Are Critical Numbers?
Definitions first: Critical numbers are the numbers that determine your company's success. When they move in the right direction, you know you're on track toward achieving your objectives. What the numbers are depends on your situation. For example:
- The crisis critical number. If your business is struggling, your critical number is whatever ensures your survival. Cash in the bank. Reducing debt. Growing sales.
- The basic critical number. That's the number that has to be at a certain level year in and year out, or you're in trouble. An airline's percentage of seats filled. A factory's output. Revenue per labor hour.
- The weakness critical number. Your sales hover around breakeven. Your return on assets is low, your inventory accuracy lousy. You're too dependent on one product. Move the number in the right direction, and you eliminate a weakness.
- The opportunity critical number. You'll rack up sales if that new product is out by August. You'll land a big customer if you reduce your defect rate. A 2% increase in operating efficiency will enable you to undercut competitors' prices.
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Determining Your Critical Numbers
If your company is in crisis, chances are you know the critical numbers already. They're the ones you worry about in the middle of the night. Otherwise, figuring out the critical numbers is a three-step process.
- Step 1: Analysis. What are the numbers that must be on track? What are your company's strengths and weaknesses? Ask managers and employees for input. Talk to lenders, investors, customers. Compare your financials with industry averages. Where are the biggest threats and opportunities in your marketplace?
- Step 2: Objectives. You can't do everything at once, so what's most important to focus on right now? If you have a strategic planning process in place, you already know your key objectives for the next 12 months. If you don't, sit down with your management team ASAP to determine one or two central goals, if only for the next two quarters. Since a company's objectives may change over time, its critical numbers may change too.
- Step 3: Determine the drivers you want to focus on. Here is where companies often screw up because objectives don't always translate into actions. A goal of lower unit cost, for example, could be achieved by boosting sales volume, by reengineering business processes, by managing labor hours or inventories more efficiently - or by some combination of these and other variables. What makes sense for your company?
Typically, one key objective should provide you with a cascade of critical numbers for people in different departments. Each department focuses on a single driver. All the drivers taken together move the company toward the goal. For example, suppose one of the goals people in your company agree on is 10% sales growth with a steady return on sales, thereby increasing profit dollars and (presumably) contributing to an increase in equity. That goal alone can spawn critical numbers for nearly everyone.
- Sales and marketing people have to bring in the extra 10%. They'll need to figure out where it's going to come from (which products? which customers?), when and how they can bring it in, and whether they'll need additional resources to realize the goal. They won't be able to sacrifice much in the way of margin, unless other departments can provide equivalent savings. Critical numbers: sales volume, gross margin.
- In a manufacturing operation, purchasing and production people have to determine how to generate additional output. Will there be bottlenecks or cost pressures in parts and materials? Any need for additional equipment? How much more labor will be needed, and where will it come from? Critical numbers: cost of goods sold as a percent of sales, along with whatever numbers are most important in determining that ratio (e.g., labor productivity).
- Customer service and other staff departments will need to support the additional 10% in sales, including supporting whatever additional personnel may be required. Can they hold general and administrative (G&A) costs steady, thus giving salespeople some leeway on margin, or at least increase them less than 10%? Can cash be used more efficiently than in the past? Critical numbers: G&A as a percent of sales (and the budget line items that make up G&A); key accounting ratios (such as receivable days).
What's important here isn't so much the specifics, which will vary widely from company to company - it's the idea that everybody's critical numbers contribute to the same set of objectives.
Copyright © 1999 Open-Book Management Inc.