Working With Key ratios

Uh oh, sounds like something that requires math skills. Well yes it does and if you can’t handle at least a little math you probably shouldn’t be in business. I’ll assume you can handle some math and I’ll try to be gentle with you.

You are getting periodic business financial statements every month and should be able to read and understand them. At the very least, you should be able to ask your bookkeeper or accountant intelligent questions about them. This is much more important than most small business owners seem to realize.

But beyond those standard and periodic statements, there is other information you can develop that will give you a good idea how your business is doing presently and will let you make predictions about the future.

Several of the businesses that I owned were based on quoting on almost all jobs. It worked like this. A customer would ask us to make a certain product to his specifications and the first thing he wanted to know was how much it was going to cost. We would create a quote based on our material, labor and other costs, add a profit and submit our bid. If our price was lower than the competition we would get the job. I think that there are many businesses that work this way – landscape contractors, construction contractors, machine shops, auto repair shops, anyone who does business with the government – you get the idea.

The key ratio that we used in those businesses was our Sales/Quote ratio. Each month we kept track of how many quotes we had submitted the prior month and also how many sales we had made in the current one. (Note that I am talking about the number of sales, not their dollar amount. Also, we assumed that there was about a month’s lag between our quote and getting the order.) Then we would divide the number of sales by the number of quotes. For example:

March sales = 350
February quotes = 760
Therefore: 350 ÷ 760 = .46

Which meant that we were getting orders from 46% of our quotes.

That could be good or bad depending on what industry you are in and how many competitors you have. In our case, we felt it was pretty good. We would have been pleased if it increased to say, 60%, but we would never want it to get to 100%. More on that later.

You might point out that we may have been getting orders from quotes generated in March and you would be right. But since we did this every month, we felt that any inaccuracies would average out over time and this gave us a reasonably accurate picture of our competitive position. It also gave us an idea what to expect in sales for each future month. If quotes were down in April, sales would probably be down in May.
Let’s look at what caused us to get only 46% of our quotes. One reason is that a competitor submitted a lower bid on that job. Another reason is that the price was simply too high for the customer and he just didn’t buy the product – whether from my company or the competition. Or the customer had another, more urgent need for something else. Or the customer used an alternate product to do his particular job. Or for any number of other reasons.

Now as to why we never wanted our Sales-to-Quote ratio to be 100%. That would mean, of course, that we were getting an order for every quote. It would also probably mean that our prices were too low and should be higher to generate more profit.

In whatever business you are in, you will be able to identify important ratios (or other numbers) that are relatively easy to generate that will give you a fairly accurate picture of how you are doing.

© 2008 by Paul Burri