Do You Know What Drives Your Business?

 

Early stage founders wear many hats. They often act as CEO, COO, CMO and CFO simultaneously, and have little time to develop a deep understanding of the key drivers that impact their business performance.

But taking the time to identify key inputs and activities that drive operational and financial results is well worth the effort. Indeed, your business success will largely depend on how well you know your business drivers, and how you allocate resources to optimize their impact.  Since many internal and external factors affect the performance of every small business, the secret is to focus on a handful of key drivers that

    • reflect the performance and progress of your business;
    • are measurable;
    • can be compared to a standard, such as a budget or last year’s figures, or an industry average; and importantly,
    • can be acted upon.

Identifying and monitoring the key drivers of your business is also critical to building a strong financial model, which can inform strategies for boosting profitability and setting internal goals and objectives.

While key drivers vary considerably by industry and company, the search generally begins in the same three areas. Regardless of your industry, ask yourself what drives:

    • sales
    • costs
    • cash flow

The next step is to undertake a root cause analysis. This is a systematic approach to identifying the underlying causes of an incident or problem and can be used effectively to determine what factors drive business performance.

In practice, root cause analysis is applied to a top line item to identify underlying influences or drivers. Once these drivers are determined, they are analyzed in turn to determine their respective drivers, and so on. When the driver can’t be analyzed further because it stems from an operational or capital decision, a key driver has been identified. Consider the examples below:

Example 1: A subscription-based business examines its key revenue drivers.

Revenue Drivers:

Volume of Subscriptions Sold x Price/Subscription

Volume of Subscriptions Sold is driven by (1) sales from the salesforce and (2) online sales resulting from search results

    • Volume 1: Salesforce = # Salespeople x Close Rate
      • #Salespeople: capital level decision = Key Driver
      • Close Rate: based on historical figures and has a cap (limited room to change).
    • Volume 2: Sales from Search Engine Optimization =  SEO Budget/CPI x Click-Through Rate x Conversion Rate
      • Budget: capital level decision = Key Driver
      • CPI, CTR and Conversion Rate: based on published rates and historical data (limited room to change).

Price/subscription: operational decision = Key Driver

In this example key drivers that impact revenues include: (1) # of salespeople; (2)  the SEO budget; and (3) the price per subscription.

Example 2: A global tea manufacturer examines its key cost drivers.

Cost Drivers:

Raw Material Costs = Tea Leaves (80% of cost) + Muslin Bag (10% of cost) + Label (5% of cost) + String (5% of cost). Focus on the greatest costs to determine the most influential key drivers (i.e., tea leaves).

    • Raw material cost of loose tea leaves/ pound: based on negotiation
      with supplier = Key Driver.

Fixed Costs = Rent (50% of fixed costs) + Utilities + SG&A

    • Rent: based on negotiation with landlord = Key Driver

In this example key drivers that impact costs include: (1) the raw material cost of loose tea leaves; and (2) the cost of rent.

Example 3: An e-commerce company is examining its key cashflow drivers.

Cash flow Drivers: Changes in:

    • Accounts Receivable: -$15k
    • Inventory: -$35k
    • Accounts Payable: +$30K
    • Prepaid Assets and other Current Assets: -$500
    • Credit Cards Payable: -$3.5k
    • Other Current Liabilities: $4.1k
    • PPE: -$5k
    • Line of Credit: -$30k

Consider the largest drivers of cash flow and analyze further:

    • Accounts Receivable: driven by # days sales outstanding = Key Driver
    • Inventory: driven by # inventory days= Key Driver
    • Accounts Payable: driven by # days payable outstanding = Key Driver
    • Line of Credit which is driven by a capital decision = Key Driver

In this example, key drivers that impact cash flow include: (1) # days sales outstanding  2) # inventory days; (3) # days payable outstanding; and (4) cash on hand from a line of credit.

Once the key drivers are determined, internal strategy goals can be set by leveraging these key drivers to maximize profitability.

The process to determine key drivers, however, is not always straightforward. At Muse Advisors, we help founders identify their key drivers and provide sensitivity analyses of their impact on revenue, cash flow, and other financial metrics. Armed with this information, you can make more informed data-driven decisions, allocate resources more effectively, and better position your company for profitable growth. To learn more, contact us here.

 

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