(This column originally appeared in Accounting Today)
There are literally hundreds of internal metrics and reports people use to evaluate businesses, and many of them can be useful. But unfortunately most of them rely on historical data which may not be too current or even relevant as markets change.
Looking at past data is, of course, important. But when evaluating a business, I do my best to look at the future. To that end, I think there are only five internal reports that really matter, which are listed below.
A few thoughts on these metrics:
- Many people like to dive into prior financial reports and pick apart obscure metrics like “defect density” or “operating efficiency rates” and that’s great, and says a lot about how well your target is run and whether or not they even have systems that can reliably produce these numbers. If you find a target like this then I’m impressed. Most of the smaller and even midsized companies I work with aren’t that advanced.
- Industries also matter. Although I feel that the metrics I’ve mentioned below are relevant across all industries, there are certain metrics that are important depending on the industry of your target. For example, I like to evaluate retail stores by looking at daily customer traffic and sales by customer. I like to look at project overage trends for construction firms. I also like to look at the realization (billable versus non-billable time) of client-facing employees at service firms.
- These metrics all assume that you’re buying an entire company with the intention of continuing to operate it as a going concern. If the value of a company is in its assets like inventory, equipment or a customer list, then these metrics may not entirely apply because your goals are different.
Value is not necessarily a multiple of sales, profits or cash flow, and I believe that companies that solely rely on these metrics are potentially misleading themselves. There’s other data that’s just as useful, and the data that gives a buyer an insight into future trends is — in my opinion — the most important of all.
This is a report that shows all pending projects, bids, estimates, proposals and quotes. It should be weighted based on the probability of closing these deals and also estimate value and timeline. This tells me the future of the business, and although the past is important, when you buy a business you’re really buying the future. If a prospective business can’t produce a pipeline report, that would concern me. Well-run businesses are managed based on what’s going to happen, not just what happened.
Sales by customer
This report looks to the past, but also says a lot about what’s coming. Not only do I like to see a year-to-date sales by customer report, but I insist on a comparison with prior years. I want to identify a company’s largest customers and see their trends. I want to see if a target business is losing or gaining customers and how good they are at keeping customers, and there’s no better way to determine this than if they’re buying products.
Sales by product
Same thing as customers, this should be looked at both on a year-to-date basis and compared to prior years. It would be great to see margins but — depending on the size of a company and the maturity of their systems — I’m sometimes dubious of these numbers. But you can’t argue with sales and knowing what’s selling — and faltering — will tell you a lot about what’s on the horizon and play a key part in whether a company is worth its value.
For this I like to see employee lists both now and from the past. I don’t just want to see headcount. I like to see names and hire dates to determine how long people have been with the company, which should give me an idea of how loyal they will be going forward. I also want to see people who left the company and find out why. This tells me a lot about a targeted purchase — is this a good company for employees? Are they loyal? Are they treated well? You can evaluate benefits but the proof of the pudding is whether or not they’re sticking around.
This may sound unimportant but I think the opposite. I don’t care if a business isn’t in the ecommerce world. Everyone is online and looking for information. I want to see that a company’s online assets — their website, Facebook page, LinkedIn, etc. — are active and growing. That tells me that there is interest in their products and services. I’m not as concerned about sales conversions or online revenues and I don’t care if they have thousands or just dozens of visitors. I’m looking for trends in activity — is the company getting more or less attention than a year or two ago? Are they on track to get greater engagement and notice going forward? Are their online assets worth anything?