Lagging vs Leading Indicators
“When we choose the wrong measurement, we get the wrong behavior” (James Clear, Atomic Habits). At the Ranching for Profit School, we talk about how paradigms, actions, and results are related to ranching. These concepts look hard at why the business does what the business does.
First let’s talk about money. A very common financial statement many ranchers rely on for decision making is their tax return, but there are many problems with that. First off, the tax return has nothing to do with economic value produced and profit retained. It is only based on cash receipts and cash expenses that occurred that specific year for cash-basis taxpayers. Second, it is not finalized until after the year is done meaning it is a major lagging indicator. For managerial decisions, it is a late and inaccurate report, so why do we use it? Of course we need it for legal and lending obligations, but avoiding income taxes is not a good way to run a business and build wealth.
How do we go from using last year’s tax return to next year’s projections? An accurate monthly balance sheet would be leaps and bounds better than the tax return, but it is still in the past, providing us with lagging information. Rather than lagging, let’s focus on leading indicators. Even though a typical cow-calf ranch may only sell one calf crop a year, there are multiple production time frames where future transactions can be analyzed. Pregnancy checking cows early, calves born alive, and a branding/grass turnout head count would all be a leading indicator of market ready animals. We can only deal with today’s market, but these indicators would at least provide us with the information on how many cattle will be available in that market. In a feedlot, it could be calculating cattle in-dates months in advance, as the current cattle will be moving out eventually. Every operation will have a production related leading indicator, but production isn’t everything.
- Lagging indicator – I review last year’s tax return and balance sheet.
- Leading indicator – I completed future stock flows with sales, expenses, and loan payments shown by month.
What about the office work? If bills aren’t paid and phone calls aren’t returned, there won’t be a business to worry about the production. Late fees are a prime example; charge accounts, credit cards, and bounced checks are all indicators of financial non-performance. It could be that there isn’t the money available to pay the bill, or that the rancher is too busy working on other things. Both are poor excuses for shorting your business partners. Business partners would also include employees. Does the business provide periodic reviews for job fulfillment and stress? Continually losing employees or business partners is a pretty obvious lagging indicator of a poor work environment.
- Lagging indicator – I pay bills when the big red “due now” stamp is on the envelope.
- Leading indicator – I sit down every Wednesday morning to pay and mail all bills.
- Lagging indicator – My custom grazing client doesn’t answer my phone calls because I only call when they owe me money or something died.
- Leading indicator – I send a picture to my custom grazing client every time I check their cattle.
James Clear also mentions in Atomic Habits that 1% better every day is the compound interest of self-improvement. Ranch managers can apply this by focusing on consistent, effective office sessions; setting agendas and timelines for yourself can streamline thought processes and discussions into timely decision making.
- Lagging indicator – I have too much work outside to sit in an office.
- Leading indicator – I am aware that ignoring decisions is a decision in itself, so I will make time to consider options and act on the best possible option in a timely manner.
By understanding the current situation and focusing on the future rather than the past, these small changes will only improve your business, both production and financially. I encourage you to read Atomic Habits to help create a system that enables you to see leading indicators of all business areas before it is too late to change those lagging indicators.
May 24, 2023 at 4:16 am, Josh Lucas said:
Great article, Jordan. My favorite analogy for this comes from Dave Pratt when he talks about the size of the windshield vs. The rear view mirror, one is much bigger than the other. We should spend our time, as managers, looking forward vs. Looking back in those same proportions. Something like 5% looking back and 95% of our time looking forward. Looking back really doesn’t do any good, it already happened, you can’t do anything about it now.
*side note: the IRS doesn’t always share this philosophy, they think their deadlines are very important
May 25, 2023 at 9:41 am, Jordan Steele said:
Thanks Josh! I always like the windshield example too; the 80/20 rule shows its importance again, but I like your proportions better. Project the future by knowing the past. And yes great point on the IRS deadlines, I see them as another business partner holding us accountable.