A familiar trap for businesses to fall into occurs around profits. It’s a relatively simple metric – it even has its own financial statement devoted to it.
On top of that, many of the performance criteria for bonuses and pay raises are tied to it.
The trap comes when profits are not considered in relation to something on the balance sheet.
Companies will quite often have profit goals and look for increases in profit over prior years and possibly even look for increases in profits relative to sales.
Far too often increases in profits have been boosted by increases in capital deployed and although profits might go up, the efficiency at which additional capital is committed is decreasing and thereby reducing the competitiveness of the business.
When you really want to give yourself an operating hurdle (and you should) – always look for a metric combination that crosses between the P&L and the Balance Sheet.