Business metrics: Measure the right things

A colleague of mine who is anal retentive passionate about his business metrics had recently revamped his metrics for 2010. And now that we’re nearly a month in, I asked him how it was going and he sheepishly admitted that he had overlooked one particular metric and wasn’t getting the right picture of his business. He made some changes and, going forward, he’s adjusted his business metrics to include all of the key components he wants to measure.

I don’t hear that kind of thing often enough in business – too many business owners just add up revenue for the day and hope that it covers their bills.

Right after talking to my colleague about his incorrect and newly corrected metric, I found this article which I thought was appropriate to him… and perhaps to you. It’s published at Money.CNN.com and is called “EVA Momentum: A New Way to Valuate Companies“.

In the article, they highlight how the executives at the now-dead Lehman Brothers were so focused on Return On Equity (ROE) that they made bad decisions but never fully understood the implications of those decisions because they weren’t impacting the numbers. And, the article goes on to say that this is common with other businesses that focus too much on other metric like gross margin or earnings per share (EPS). Then the article puts forward a new metric that it says is bulletproof and potentially the best metric that investors can use to analyze a business (and businesses can use to analyze themselves).

Before I get to the metric itself, let me say a couple of points of clarification: I’m sure that the executives at Lehman Brothers may have been focused on ROE but still made risky decisions and knew they were doing so. Also, I’m sure that this “bulletproof” metric might be really good but we may eventually discover that it is not as magical as we thought it was.

Okay, so here’s the metric: It’s called EVA Momentum. EVA stands for Economic Value Added and it is basically a company’s profit after deducting all the capital in the business. EVA Momentum measures the change in a company’s EVA divided by the prior period’s sales. Read the article for a nice clear example.

I realize that this might be pretty specialized for some users, but for others, it could be the metric you’ve been looking for to rate the health of your company (or your investments).

Think about it and let me know your reactions.

Jessica Routier, IAC-EZ