Small businesses need to find the edge over the competition wherever possible. A major element in that concept is tracking the right business metrics. There are several key indicators that help you decide when your business is due for growth, whether you have a bottleneck in your path to success, or if there is a hole in your strategy. In this post, we will go over some of the most important financial metrics to keep an eye on.
1. Cost of Goods Sold (COGS)
This is key. Without breaking out your cost of goods sold over time, across different products, and through other difference-makers, you won’t understand where your profits come from. It is all very well and good to see big revenue numbers, but without taking into account your production costs, you aren’t really learning anything about the health and long-term viability of the business model. This is especially important for a young and growing business, because it is tempting to generate a lot of revenue with low prices to gain market share early on. However, if you can’t start generating an actual profit over your costs, you will eventually burn through your cash.
There are a few things you can learn from your cost of goods sold. First of all, you can see how your costs are changing. Even in isolation, this is useful to know. You can see if your production is getting more efficient and reducing your costs, for example, or if switching suppliers affected costs. That helps you make sure your costs aren’t creeping up or eating into more of your margin unexpectedly. This is especially important during expansion, because new products often cost the most to sell at launch, with costs coming down. If you expect costs to decrease over time, then you should see indicators of that in the cost of goods sold.
You also need to be able to break out the margins of each product. It is okay to have a loss leader that you take a thin loss on if that leads to more purchases of profitable items later on, but you can’t handle sustained losses. The last few years of the tech sector should be enough to show anyone how dangerous it is to build your business model around years of losses, especially when there is no concrete plan to swing into the black.
Cost of goods sold is one of the most crucial financial metrics both in aggregate and in fine detail, so keep a close eye on it. It could be the key to many things, from pricing and growth to R&D and support.
2. Customer Acquisition Cost
Next up we have another cost. Customer acquisition costs are all the costs associated with converting a lead into a customer, and they generally consist primarily of marketing and sales dollars. This is an area where it’s easy to overspend. If your CAC is too high, then you need to find a way to increase conversions or to spend less money and get the same results. Spend too much on sales and marketing and you will run into problems; the margin of revenue over cost of goods sold will get wiped out when you take into account CAC. Sales and marketing are both highly complex fields in today’s business world, so it isn’t easy to find the best and most efficient approaches for your needs, but spending some time on sharpening your strategy is key.
Most marketing (and much of the sales process, especially at big companies) today has at least some online component, and it might be completely online. Online marketing tactics such as email and social media tend to be cheap and high-volume, so they are attractive to small businesses. Some of the big costs come in, however, on larger tactics such as SEO and web design. It is increasingly common to outsource these to marketing companies. This is not necessarily a bad move. It’s rare for a small business to have the internal talent and time to spend on SEO-oriented web design so it makes sense to seek out those who do and partner with them. However, costs can potentially run high when working with outside vendors, and what makes matters more difficult is the necessity of paying for the work before the increased revenues from new sales come in. In addition, accounting can be a little tricky as well, if you don’t remember to include some of these costs in your total CAC.
As with cost of goods sold, CAC is useful if you can break it out by type of customer, the channel, the things the customers buy, and so on. That will help you see where your marketing is most effective, what kind of groups you are efficiently converting, and whether high-CAC customers go on to buy enough to justify the costs to acquire them. This last point is important. If you are trying to increase conversions among a particular group and are spending a lot on marketing, more conversions don’t mean more profits if those customers are buying low-margin items. When possible, increase the efficiency of your marketing by funneling potential customers to products with better margins.
CAC is also a key financial metric to keep you focused on retention. Visualize how much you need to spend to bring in a new customer and how much uncertainty there is associated with that process. For less money and less effort, you can keep existing customers and make them into repeat business. The saying in business is “the best customers are the ones you already have” and that holds true even today.
3. Cash Burn Rate
You’ve heard the phrase, “you have to spend money to make money.” Nowhere is this phrase more relevant than in business. If you want to expand and make a splash, you need to be willing to invest early on in the life of your business. However, that doesn’t mean you have to use up all your cash in the first six months, either. Half of all small businesses fail in the first year and one-third fail in the first two years. The main reason for this high failure rate is a lack of cash flow. Businesses simply run out of money to sustain. The founders fail to foresee how long it will take before their company starts to turn a profit, or underestimate the day-to-day costs of operating. To be safe, always go into a new business with the mentality that you might need to eat a year’s worth of costs before profit comes in. The cash burn rate is the right metric to monitor how much longer you can stay afloat.
While the first two metrics we discussed were specific types of cost, the cash burn rate is more overarching because it provides an all-inclusive look at sustainability. It’s easy to calculate how much longer you can maintain your current state and when you will need to start turning a profit.
The cash burn rate is also a good reality check for business owners. It’s easy to get excited in the early days of big spending and growth. Checking in with your burn rate helps you see just how unsustainable that is, keeping you grounded and in tune with long-term realism. That initial growth phase won’t last forever, and by looking at your monthly or annual pace for spending, you’ll see that your revenue will fall short of expenditures until you start to convert efficiently and build a loyal customer base. Cash burn rate doesn’t tell you where your money is going or whether it is being well spent, so you’ll need to connect the dots a little to decide whether you are making good use of your resources. It is most useful as a sort of ticking clock, a countdown of when you’ll be forced to seek exterior financing or shut down. The more you can reduce your burn rate while increasing revenue, the quicker you can swing into profitability.
All three of these metrics are costs. You want to focus on costs because they guide many decisions in all realms of business. These are also metrics that many owners underappreciate. They key in on helping you reach profitability and avoiding burnout. In the modern, heady market with startups and online platforms making entrepreneurship accessible, it’s more important than ever to stay calm and locked-in on the long-term sustainability goal. For every Facebook, there are a thousand new businesses that flame out and go unnoticed because they never developed a way to make a profit. By focusing on these three core metrics, you’ll see exactly where and how you can improve your efficiency. Consider this an introduction to the world of business intelligence. The right data can change your entire perspective and deliver powerful insight across each part of your business. That includes visualizations and graphs as well as raw data. Look into getting a good BI dashboard that can bring these and other metrics within easy reach.
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