Sound planning begins with realistic and achievable goals. As we begin the new year, it is a good time to step back, reflect on past results, and use the data for future planning. How do you use past data most effectively? How can annual performance figures translate into usable benchmarks for evaluation of everyday performance?
Using Data to Establish Target Ratios
We suggest establishing “target ratios”. Target ratios are current numbers, reflecting what you should be able to achieve within your company’s particular set of circumstances at this moment in time. As your circumstances change, so will the ratios—underscoring the need to constantly track and compile the numbers. Your target ratios might not match those of national profit leaders, but analyzing them will give you a good idea why variations exist and provide insight as to the achievability of the targets as benchmarks.
Important Ratios to Consider
The chart below depicts examples of important financial indicators based on information from the balance sheet and cash flow.
What do the target ratios tell you?
• Current Ratio. As the indicator of your working capital, this immediately tells banks and vendors if you can meet your operating obligations in a timely manner. Taken alone, current ratio is a snapshot of where you are, but when tracked over time it also shows where you are trying to go. Achieving a 2:1 ratio shows ability to withstand losses or even a down year. We recommend you monitor this monthly.
• Debt to Equity. This leverage indicator not only shows how much debt you have, but your ability to repay it and to withstand a down turn. In a highly capitalized industry like commercial printing and packaging, we like to see no higher than a 4:1 ratio here, but for most industries a good goal is 2:1.
• Cash Flow Coverage (Fixed Cost Coverage Ratio). This is perhaps the most important of your key indicators, and is the standard ratio used by banks to determine if you are generating enough cash to pay your notes. Most banks today may want this information on a quarterly basis, or on a monthly basis for troubled companies. Failing to meet this ratio because you have had a bad year results in a covenant violation and might open potential actions by the bank—increased rates, penalties, or restructuring your entire arrangement. We like to see our clients maintain 1.25 here since the covenants in those bank agreements are typically 1.1 to 1.25.
• EBITDA as a Percent of Sales. This indicator allows you to compare your company to others of your size in the industry. In the mergers and acquisitions arena for the printing and packaging industry, prospective buyers are looking for companies that are at least at the eight percent minimum. This ratio is typically monitored annually, although it can also be done throughout the year.
There are many ways to evaluate performance. Discuss key indicators among your management team to determine the most critical ratios to watch and the best benchmarks to use, then set goals accordingly for on-course performance and prosperity in 2014.
Stuart Margolis, CPA and partner at MargolisBecker LLC, provides information that helps firms operate profitably. The company is the purveyor of the industry’s “Cash is King” and “Value-Added Principles of Management”, and compiles the annual Printing Industries of America Ratios, the industry’s premier financial benchmarking tool. More information at MyPRINTResource.com/10164246.