- Do you have management information for decision making? One of the biggest holes in many business owners knowledge is a basic understanding of the key numbers. Not just Profit and Loss, Cash Flow and Balance Sheet, but the main drivers and levers within their businesses.
Do you have management information for decision making? One of the biggest holes in many business owners knowledge is a basic understanding of the key numbers. Not just Profit and Loss, Cash Flow and Balance Sheet, but the main drivers and levers within their businesses.
Not knowing your numbers is a major handicap – you cannot plan or forecast effectively, you cannot manage cash flow (unless you always have a significant surplus) and you won’t know what products and services really make you money and profit!
There are some critical questions to ask about your business that only the numbers can tell you:
Decision Making – Is the Business Viable?
Almost the first thing you need to do with any business idea is test it – test it to destruction! There is only one thing worse than an idea that doesn’t get implemented and that’s spending time and money implementing an idea that no one wants!
I’m sure you can remember at least one potential entrepreneur on Dragon’s Den or Shark Tank that was seriously deluded about potential demand their product. Equally there have been amazing ideas that the inventor just hasn’t been able to articulate the value because they didn’t know or understand the numbers easily.
Sometime that’s the pressure of being in front of both the TV cameras and 5 powerful, intimidating people of influence – more often it’ a lack of attention to the information that is most important to a potential investor.
If you haven’t started, then a good place to start is with some basic viability questions and actions:
- Research the market
- Find out if there are paying customers (not just your friends who say they will buy but actual people willing to hand over cash!)
- Get honest feedback – and listen to the good and the bad
- Plan your marketing strategy
- Assess the overall costs of the venture
If your business starts to look viable, then pass it through a next level test:
- What’s your unique service / value proposition? – What makes you stand out? (BIG CLUE – It is NOT customer service!)
- Do you have funds to start it up? Do you know how much it will take?
- Who are your customers? – knowing this will allow you to focus your marketing.
- What else is in the market? Who are your competitors?
- Can I generate positive cash flows that support the overall costs of the business?
One of the major factors in business success is TIMING! Changes in the economy, in technology, in social attitudes can all influence the outcomes for your fledgling business.
Bill Gross gave a TEDx talk in 2015, and after analysis of success factors in 100’s of Start-Ups, was surprised by the outcomes. He wanted to find out why so many failed! He wanted to know what influenced success.
He used to think that the IDEA was the key, though he also looked at the TEAM, the BUSINESS MODEL, levels of FUNDING and TIMING. Having looked at 200 companies, he judged that for 42% of all the companies, TIMING was the biggest factor in their success. This was followed by TEAM at 32%.
Surprisingly FUNDING was the last factor in the list.
Decision Making – The Essential Numbers
Each business has its own drivers and essential numbers. In a property business is will be % occupancy rates and rents outstanding, for example. In manufacturing companies there will be some measurement of stock levels and stock utilisation. Where a key factor is retained income, the retention rate will be measured. There are some basic numbers that all business owners should know and have access to on a regular basis – at least monthly.
Some critical numbers you need to have a basic understanding of include:
- Sales (value and volumes)
- Profit margin
- Cost of customer acquisition
- Marketing Return on Investment
- Staff costs
- Revenue per employee
Decision Making – Sales
Often measured in volume and value, Sales are one of the easiest and most commonly measured Key Performance Indicator in business.
However if you are selling products or services at a loss or such a low margin that you don’t cover your overheads, then increasing the volumes will only generate more problems going forward as the cash flow from sales will not cover the expenses incurred.
“Turnover is vanity and Profit is Sanity!”
It’s not just the sales margin that’s important but also knowing where the product is in its life cycle. Initial launch of a product may demand more marketing, PR and education than a mature product which has declining sales volumes, but which requires no further development investment.
Equally with a small amount of development or repositioning in a new market, an existing product could have a revived and extended life.
Selling methods will vary from business to business – from passive reliance on awareness and demand (a sandwich shop near a major office block for example) through to the educational journey for technical products that require specialist knowledge from both the sales engineer and the prospect.
Understanding sales cycles is essential for the business to be able to plan, purchase stock and manufacture as well as letting the customer know how long they may have to wait for their delivery.
Decision Making – Profit Margin
Gross Profit is calculated by deducting the cost of the sales, which is the variable costs of producing, or providing services from the revenue, (sometimes known as sales, turnover or income). You’ll often see this converted into a percentage and described as Gross Margin.
Gross margin % = Gross Profit x 100
Take revenue to be £100, deduct £35 cost of sales and the resulting gross profit is going to be £65 and the GM percentage will be 65%.
Your revenue less your cost of sales is gross profit.
Why is it important to know your Gross margin?
The amount of margin made per sale acts as a contribution towards the company’s overheads. Knowing how many sales you need to at least break even will allow the setting of targets and management of cash flow.
Using a football analogy, if you know the score then you know what it takes to win – when your team is 2-0 down, then they are very focused on scoring 3 goals! The team knows exactly what it takes to get the result they want.
Managing the gross margin is a critical number that every company needs to monitor and track. A failing of many start-ups is not having an understanding of the margin needed to maintain a healthy company.
One of the main causes of business failure is lack of cash – this is often a symptom of poor margin control.
A relatively small change to the gross margin can have a significant impact on the business as a whole. You need this number to calculate your breakeven point.
Cost of Customer Acquisition
In the 21st century Marketing has become more of a science! It’s as much about the numbers as it is about creativity. One of the most important numbers is the cost of acquiring a customer.
If you don’t know the cost of acquiring a customer than you can’t measure how effective your marketing is.
To get started, let’s look at the why this is important. I’m going to use Jenny’s Cakes as an example (this is fictional company based on a true story)
Jenny has been a keen amateur baker for as long as she can remember. Weekly she has been taking cakes and other baked goods into the office and coming home with the few crumbs as her colleague devour every morsel. She often bakes birthday cakes and takes the occasional commission for special occasions.
Jenny’s just been made redundant and the idea of going and getting another job just doesn’t have the pull it once did.
She wants to break out on her own – and everyone who has tasted her cakes has always said “You should do this for a living!” So she decides to take the leap decides to start selling cupcakes.
As a baker of some experience she knows she needs better facilities than her home kitchen currently offers so she gets quotes for getting industrial ovens and double sinks, converting her utility room so she can pass all the food hygiene requirements.
Jenny also knows that she can buy her ingredients whole sale so reduce her costs of production. She calculates the cost of producing all the different cakes and pastries she is planning to make.
So now Jenny knows all her costs – the investment in facilities, the cost of making goods, the overheads she will incur. The only thing she hasn’t factored in is the marketing spend – at the moment she has no idea what her cost of customer acquisition is.
Before she starts work on the new kitchen and before buying wholesale amounts of ingredients, she does some market research. She bakes a small range of the products she is planning to sell and arranges to talk at some local events where her customers might be. She is not planning to open a traditional shop, instead she is planning to build a mail order business for cakes. She is also planning to supply local cafes and businesses with bakes goods and external catering. She engages with the local Chamber of Commerce and provides the catering for a couple of their meetings.
After her initial research she gets some orders and decides to go ahead – spending most of her redundancy money on the conversions. She has 6 key local clients and it has cost her about £500 in ingredients plus her time.
To build her mail order business she knows she will have to advertise using Pay Per Click and Facebook / Instagram – none of this is natural to her and she knows she hasn’t got the time to learn so she engages a marketing agency to do the work for her. This cost is £500 per month plus the marketing spend. She treats the first 3 months as an investment but after that cost of the agency needs to be recovered in the volume of sales.
After 1 month she is generating leads and traffic to her website at a cost of 76 pence per visitor. Her conversion rate is 3%, which means that for every 100 visitors to her website she gets 3 sales. The average sale value is £15. She has a margin of 70%.
100 visitors costs Jenny £76.00
3 sales at £15 is £45.00
Her gross margin is £31.50
This means that before the agency fees (which are classified as overheads), Jenny’s cost of customer acquisition is much higher than her profit margin and she is losing money.
HOWEVER, Jenny notices by the 2nd month that her cost per visitor is starting to reduce. And by the 3rd month Jenny see’s that her customers are coming back and taking regular orders. This means that over 3 months she can see that the average order value is still £15 but customer are ordering more than once. She decides to stick with the mail order, reviewing her numbers on a monthly basis.
After 6 months Jenny can see the following numbers:
100 visitors costs an average of £60;
Conversion rate is now 4.5%
Average order value is £17.50
Customer order 2.25 times in 6 months.
Gross margin £124.03 – less £60 cost of acquisition = £64.03
She can see that her marketing activity is now generating over 1000 visitors a day to her website. Jenny is covering the cost of her overheads, including the marketing agency fees and repayment of the overall investment. This allows her to continue growing her business. Because she has the numbers she can plan her cash flow AND look at when she will need to expand her facilities and / or rise her prices because of demand.
If she didn’t know these costs and indicators she would have no idea whether her marketing was working, and how much it was costing her. She may even have run out of cash and gone out of business without being aware that she was in such circumstances.
Decision Making – Marketing Return on Investment
There is a lot of hype about social media being THE marketing panacea. On one hand the number of LIKES, FOLLOWERS and COMMENTS does not automatically convert into sales and are often vanity numbers.
On the other hand being picked up by a major influencer (someone with a lot of followers) can explode your business and cause your website to crash.
Designers and retailers see a surge in demands whenever super models, the Kardashians or the Duchess of Cambridge are seen wearing someone’s clothes or accessories. Aside from a stroke of luck or exceptional PR, many small (and large) companies spend more time on social media in passive exposure than in focused, direct sales and promotion activity.
Measuring the amount of time and money spent on each activity allows you to track the return on that investment. Most businesses do not measure – they just think “I must do social media” and then wonder why it’s not generating the sales that other activities can and will do.
The key to marketing is understanding what you spend your money on, measuring the impact and making sure you are getting a return.
“Half the money I spend on advertising is wasted; the trouble is, I don’t know which half.”
John Wanamaker (1838-1922)
Savvy business owners know what they are spending their money and time on, and they know what the returns are by monitoring it. There are a number of free tools – one of the most powerful is Google Analytics. There are too many other free and paid analytics tools on the market to mention.
But never underestimate the use of a simple spreadsheet and a couple of key numbers such as:
- Website visitors (including where they originated from!)
- Conversion rates (sales)
- Abandoned baskets
- Returning visitors
- Repeat sales
Understanding the cost of each will allow you to know what your Return On Investment (ROI) for each is – and you can make decision on your marketing investment for the future.
Decision Making – Overheads
It might seem obvious to know what your overheads are in detail, but one of the quickest ways I have been able to reduce costs in any business is by asking what they are spending money on a regular basis. I often find that there are subscriptions, overpayments, direct debits for unused services etc.
Most commonly businesses have signed up for a service and are paying a retainer for something that is of no value to the business or they can get elsewhere much cheaper.
Undefined retainers are my favourite for this – they are frequently expensive and with no specific measures of return on investment and offering little value. After the first few honeymoon months, many retained services become lazy.
Once you are an established client, the retainer service start to just go through the motions whilst focusing most of their time getting and impressing new clients. The secret is to make sure services and outcomes are defined so that you know the value they are adding and that it shows in the numbers!
A regular audit of overheads is worthwhile to make sure that the business is getting the service promised – and the renegotiate the contract if things have changed. This takes less time than the potentials savings and is good practice, though often neglected in the cut and thrust of day to day activities. Any decent finance function will always be reviewing all costs in a business as a matter of course.
Overheads = Gross Margin %
The level of overheads defines the breakeven value and volumes in a business. The breakeven number is important to know and understand.
If overheads are £25,000 per month and gross margin is 40%, then sales will need to be £62,500. If the average sale is £100 then 625 sales are needed – that’s a little over 20 per day!
Knowing the sales target is much easier to track and make decision on what marketing activities to pursue.
Staff are usually the biggest overhead expense of any organisation. And keeping your spend within acceptable limits can be a challenge especially if you pay by the hour and somethings goes wrong. For example, when a customer needs something urgently and your staff work overtime. Unless the overtime cost is built into each sale, your margin will be reduced.
One measurement to use for measuring a trend in your staff cost is the % compared to sales. It’s a rough measure at best because if sales are not consistent then your staff cost % will go up and down and not necessarily make sense.
Over time you will see a pattern. An upward trend means your business is either not in control of staff costs or is not benefiting from economies of scale!
Note: If you are growing or have staff turnover then this will impact the calculation as you will be investing in more staff and paying for the impact of their learning curve.
It does not negate the need to look at this measure, but the results should be considered in light of the changes in your business.
Revenue per employee
One easy way to compare companies of different sizes is to use the Revenue per Employee ratio.
Take an example of one company over 2 years:
- Year 1 has a turnover of £9m, 26 staff and profits of £845k
- Year 2 has a turnover of £14.7 million and 31 staff, with profits of £1m
Is this company getting more successful?
- Year 1 shows a profit margin of 9.3% and has a revenue of £346k per employee.
- Year 2 shows a profit margin of 6.8% and has revenue of £474k per employee.
Whilst in year 2 makes a lower margin, the use of staff is more efficient. Lower margin may result from a step up in overheads that will be absorbed by further growth. Year 1 has a higher profit margin (operating costs may have been optimal for the size of the business) and a less efficient use of staff, possibly as a result of growing a new expanded team – investing in training and process improvements.
Using one year as a bench mark for staff costs, the company can see whether it is improving the profit margin and maintaining efficiency in staff utilisation.
So what’s your revenue per employee now? And in the past?
BOOK RECOMMENDATION: 5-Minute Finance by Christine Nicholson
For business owners who don’t know or understand their numbers or basic finance and don’t have time to learn.
5-Minute Finance covers the basics in understanding finance terms and the minimum basic level of understanding of numbers and finance language – it’s designed to be business owner friendly and can be read in 5-minute chunks, with the whole thing readable in 90 minutes.
Note: this book was written for one of my clients who benefited from it so much that I decided to publish!
Numbers Case Study – MOONPIG
Moonpig Secret to Success
Nick Jenkins, of Dragon’s Den fame, pioneered on-line personalisation with the greeting cards company Moonpig. Starting in the early days of the Internet meant he had to learn all the lessons himself because, as he said in his own words “I didn’t know what I was doing, but neither did anyone else!”
Initially the price for the card was set at such a low price that Moonpig was at risk of going bust by having too low a margin and too high a cost of customer acquisition. Analysis of the numbers meant they could take the decision to raise prices, knowing that not to do so would be disasterous. The stark choices were:
- Raise prices to survive, with the risk of losing customer and possibly going bust;
- Not raining prices and going bust anyway!
They raised the price and noticed almost no loss of customers – but saved the company!
Facing Cash Challenges
Having no money to “waste” on marketing, they became exceptional at analysing every aspect of consumer behaviour.
He compares the customer journey to the Olympic sport of curling where a 20kg carved and polished “rock” is glided on ice towards a target, in a similar concept to flat green bowling. On route the team members “polish” the ice in front of the stone with brushes (brooms), smoothing the route to get as close to the target as possible – eliminating as much friction as they can.
In the early days of the internet building an ecommerce website was extra-ordinarily expensive (no Shopify for $99 a month!) and all of the focus in Moonpig was on making the customer experience as easy as possible. Constant split testing of both the content on display and how each customer was behaving – where they got stuck or stopped, where they clicked and when they stopped in the process. Removing any friction was critical success.
There weren’t the technical tracking tools (such as Hotjar, Crazy Egg or Sumo Me) available in those early days of e-commerce. Knowing past customer behaviour allowed them to predict future buying patterns, though this did not stop continuous testing and tweaking of every aspect of the prospect and customer journey to get the best results.
Commitment to Customer Service
Everybody in the Moonpig team was committed to giving the best customer experience, every time. Nick gives one example of a large personalised card being ordered for a retiring Head Teacher in Nottingham that didn’t arrive in time. When the customer rang up and told the story of why it was so important, the card was immediately re-printed and couriered to the school so that it could be signed and presented.
This was way beyond the cost of the card, but a great deal of goodwill was generated from the customer and boosted the positive feeling staff had about delivering excellence.
Test every channel
Moonpig tested every marketing channel, looking for those that were scalable. Knowing what the typical customer spend was became critical to scaling their marketing activity. This meant analysing their customer behaviour, how long they stayed a customer and how many new customers they referred.
Key questions the Moonpig team asked were:
To attract 100 customers:
- How much does it cost?
- How many of them buy?
- How frequently do they buy?
- What is the average order value?
Knowing these numbers meant the team at Moonpig knew exactly how much they could spend on getting a lead and then the conversion rate and ultimate cost of acquiring a customer.
Finding the Game Changer
The critical turning point for Moonpig was trying television advertising. At the time it was perceived to be extraordinarily expensive but when they investigated it worked out to be very cost effective. The trigger for investing in TV advertising was seeing a new competitor in the market in the TV. Knowing their numbers and the cost of getting a customer from the constant analysis of lead generation and customer behaviour meant they knew exactly how much money they were willing to invest. They understood what results they needed to establish TV advertising as a successful marketing pillar.
When Moonpig discovered that their cost of customer acquisition was much lower through television advertising, they started to grow the investment, doubling their spending each month. At one point they were spending £1m per month on this marketing activity. As with all marketing pillars, there does come a point of diminished returns and knowing the numbers allows this to be tracked so you can build then next marketing investments.
After months of doubling up on their spend, the acquisition rate started to plateau and they identified their optimal TV advertising spend.
After years of battling to establish themselves in the market and with external investment of £3m, Moonpig was sold in 2011 for £120m, giving investors a x40 return on their investment.
Very happy investors indeed!
Are you stuck in the day-to-day of your business with no time to plan for the future? A Professional Business Mentor is just the leverage you need to get out of the rut and flying. Discover how you can make your business worth more AND avoid leaving money on the table when you finally leave your business. Click here to contact Christine by email alternatively you can book a call with the Business Mentor of the Year 2020, author and speaker. Who helps business founders get their businesses exit ready so they can enjoy a happier, richer future. She saves them THOUSANDS and increases the value of their businesses by MILLIONS.