An Executive Support System (ESS) is a software solution that can help CEOs to make more pro-active and informed business decisions. The system works by aggregating and comparing data from across a company’s accounting, sales and other processes.
Looking at key metrics in each area of a business, the ESS will calculate helpful ratios like AP/AR ratios, Z-score and Days Inventory, which can all indicate the overall health of a business and help CEOs to make important, forward-thinking decisions.
At Brightmetrics, we recognize that most CEOs do not have a formal financial background, so our ESS also explains how each ratio is calculated, what the ratio means and what the executive can do to bring his ratio back to a healthy level. It would take a talented CFO’s skill set and time to crunch the numbers and come up with the same insights that an ESS generates automatically.
To give you a better idea of how these ratios and insights work, lets take a peek behind the scenes at some important ratios our ESS tracks. Below we’ll share three sample ESS ratios and resulting insights that you might see in the ESS dashboard. You can see from each example how the ESS provides essential insights for any CEO.
1. Accounts Payable (AP) / Accounts Receivable (AR) Ratio
This metric represents the average days in which you pay suppliers over the course of a year (AP) versus the average days in which your customers pay you over the course of a year (AR). The AP/AR ratio should never be below 1, as this would mean that you are paying your suppliers more quickly than your customers are paying you. If the ratio drops below 1, it could lead to cash flow constraints. AP days should also always be higher than AR days. If AP is not higher than AR, it means that you are financing your AR and likely making 0% interest. You will need to have much larger cash reserves in order to continue this practice.
Here’s an example of a potential AP/AR ratio alert that an ESS might show and the recommended action for the CEO to take:
ESS Alert: Your AP/AR ratio is higher than past values AND your AR days is lower.
What this means: You are receiving money owed at a faster rate than normal. This means your collections are operating more effectively and will have a positive impact on your cash flow.
What to do: There may be opportunities to put your positive cash balance into very short-term interest-bearing vehicles in order to maximize your profitability. You should also consider your inventory situation. If your inventory is turning quickly, it may be beneficial to use this increase in cash flow to purchase inventory in bulk at favorable terms. Remember to always keep inventory at a reasonable level, and do not over-invest in inventory.
A z-score is a weighted combination of several common business ratios that reveals how likely it is that the company will become bankrupt in the following 12 months. A low z-score (below 1.1) indicates a high risk of bankruptcy within 2 years, while a high z-score (especially above 2.6) indicates very low risk. Real world use of this metric has successfully predicted forthcoming company bankruptcies approximately 72 percent of the time two years before bankruptcy filings.
Here’s an example of a potential z-score alert that an ESS dashboard might show and the recommended action for the CEO to take:
ESS Alert: Your z-score is lower than past values AND your Working Capital is lower.
What this means: A drop in Working Capital means that cash is draining from your company. A significant reduction in this metric means a company is having difficulty converting raw materials and labor into cash. The decrease in Working Capital is contributing to your lower z-score.
What to do: A decrease in Working Capital is cause for concern. Monitor this closely to make sure it is not or does not become a trend. The most significant factors in calculating Working Capital are inventory levels, accounts receivable, and accounts payable. First check your inventory. Are you turning your inventory at an appropriate pace? Too slow a pace means you will have cash flow problems and too fast a pace means you may not be able to respond to customer demand. Then make sure your accounts receivable is outpacing your accounts payable. If you are paying your vendors more quickly than you are receiving payment from customers, it means you are financing your customers’ purchases with your own cash and that is a hit to not only your cash flow, but also your bottom line profit. Keep an eye on these areas to make sure they are heading in the right direct.
3. Days Inventory Ratio
The days inventory metric indicates the number of days it takes to sell inventory on hand over the course of a year. If the days inventory is too low it may mean that you have been experiencing really strong sales or that you’re not purchasing inventory quickly enough. A higher days inventory metric can mean you have poor sales and excess inventory or you are purchasing too much inventory. An imbalanced days inventory metric can impact your ability to react to unexpected orders. If you cannot meet order demand on time, it can result in lower customer satisfaction and perhaps missed orders.
Here’s an example of a potential days inventory alert that an ESS might show and the recommended action for the CEO to take:
ESS Alert: Your Days Inventory ratio is higher than past values and your Inventory Assets is also higher.
What this means: Your inventory assets are higher because you are continuing to purchase goods that are not leaving your inventory.
What to do: If you’re purchasing inventory based on a projected increase in demand, then this is okay. For example, if seasonal demand in your industry is projected to spike and you expect to move a lot of inventory as a result, it is acceptable to see a jump in days inventory and inventory assets. However, if you do not anticipate a projected increase in demand, then you may be seeing a decrease in demand and you should reduce purchasing accordingly. Examine strategies such as reducing additional purchases, or look at short-term ways to sell off unwanted inventory.
As you can see from these quick examples, having an ESS is like having a really talented CFO looking over your shoulder. This is just a peak into the high-level insights that an ESS offers. For more information about the Brightmetrics ESS, or to sign up to be a design-phase software user, please leave a note in the comments or get in touch with me at firstname.lastname@example.org,