Measuring What Matters: The Metrics You Can't Live Without

As a business owner, tracking your company's performance is essential to understanding how well you're doing and where you can make improvements. In this post, we'll go over some basic business performance metrics and how to calculate them.

While widgets and lemonade stands are commonly used examples, we'll take a different approach. Instead of lemons, life has given us limes - and we plan to make margaritas with them.

Quick Links

1. Revenue
2. Burn Multiple
3. Customer Acquisition Cost
4. Churn Rate
5. Accounts Receivable Turnover (ART)
6. Inventory Turnover

Revenue

What is it?

This one feels like a no brainer but it's always worth repeating. Revenue is the amount of money your business earns from sales. If you sell subscriptions, you'll want to consider your monthly recurring revenue (MRR) and annual recurring revenue (ARR).

Examples

If we sell 50 margaritas for $10 each:

If we sell 50 Bottomless Margarita memberships for $200 per year:

*We're keeping it simple here, but as customers churn, you would subtract that lost revenue.

Why is it important?

Understanding trends in your revenue can help you identify key drivers and changes in your business. Knowing your customers purchasing habits can inform your marketing campaigns, inventory needs, as well as any cash reserves needed to weather seasonality.

Profit (and Margins)

What is it?

Profit is the money you have left over after expenses.  It is the top indicator of your company's financial success and performance. Profit can be reinvested back into the business, payoff debt, saved for a rainy day, or distributed within ownership. There are two ways to look at profit:

• Gross Profit - The revenue you have left after subtracting your COGS. This provides insight into the profitability of your company's core operation. It can tell you about your pricing model and whether you're producing your goods cost effectively.

• Net Profit - The revenue you have left after all of your expenses, including COGS, operating expenses, taxes, and anything else. This is your company's true financial health since it takes into account all costs associated with running the business.

Next, margins show what percent of your revenue is profit:

Example

Notice anything different between these two numbers?

	Profit	Margin
Gross	$500 revenue - $150 COGS = $350 Gross Profit	$350 gross profit / $500 revenue = .7 or 70% Gross Profit Margin
Net	$500 revenue - $150 COGS - $200 expenses = $150 Net Profit	$200 net profit / $500 revenue = .3 or 30% Net Profit Margin

Why is it important?

Profit is the lifeblood of a successful business. By understanding your profitability and the factors that drive it, you can identify areas for improvement and make informed decisions to keep your business on track.

It's also important to look at both gross and net profit together because they tell you different things about your business. If you have good Gross Margins but negative Net Profit, you may want to look for bloated general expenses like rent and support function salaries.  If your Gross Margins are low, your core product generation isn't profitable.  You may want to evaluate your pricing, seek more affordable raw materials, etc.

Cost of Goods Sold (COGS)

What is it?

COGS is the sum of the costs and expenses directly related to the production of goods. This could include raw materials, products you are reselling, packaging, and direct labor related to producing the good.

 

Example

If each of those margaritas costs us $3 to make (limes, liquor, ice, cups), our cost of goods sold is $150 (50 margaritas x $3 in raw materials).

Why is it important?

Like revenue, trends in your COGS can signal changes in your operation. This is particularly valuable during times of changing supply chain, inflation and labor rates. Monitoring your COGS allows you to quickly adapt to changes and keep your bottom line healthy.

Burn Multiple

What is it?

Burn Rate tells you how quickly you consume your cash. The Burn Multiple adds context to tell you how efficient you are at turning that spending into revenue growth.

Example

Let's take a look at the first few months of our Bottomless Margarita membership:

At first, our burn multiple is higher (👎) because we had to lay out more cash to get started and didn't have many customers yet. This starts shifting as our net new revenue increases compared to our spending.

Why is it important?

The lower the burn multiple, the better you are at turning your spending into growth. This helps cash last longer, extending the runway and reducing dependency on raising additional capital.

The multiple you should target depends on your industry and age with 1-2 being a general target.

Customer Acquisition Cost (CAC)

What is it?

Aptly named, CAC is the cost of acquiring a new customer. To calculate your CAC, divide your total marketing and sales expenses by the number of new customers acquired in the same time frame.

Example

Let's assume each marg was sold to a different customer (50 different customers). If we spent $50 on marketing and sales to acquire those 50 customers, our CAC would be $1.

🔥Why is it important?

CAC is hotly debated on its importance because it lacks context on its own. After all, who cares if you spent a lot obtaining a high-value customer that makes big, repeat purchases over the course of a long customer lifetime? That said, even without context, knowing your CAC and how it has changed over time is an essential starting point.

Next level

Add context with additional metrics:

• CAC Payback tells you how long it will take to recover your acquisition cost. To calculate, divide CAC by (ARR - Average Cost of Service).
• LTV:CAC Ratio compares the average lifetime value of your customers against what it took to acquire them.

Churn Rate

What is it?

Churn rate is the percentage of customers who stop purchasing within a certain period of time. To calculate your churn rate, divide the number of customers lost during a given period by the total number of customers at the beginning of the period.

Example

If only 10 of our margarita customers come back again this month, we churned 40 of the 50 customers. Our churn rate for the month is 80%.

Why is it important?

It's cheaper to retain a customer than get a brand new one! High churn rates can indicate customer satisfaction and retention issues. If you're looking to improve profitability, retention is a key piece of the puzzle.

Next level

To take it a step further, consider your churned revenue instead of customer count. As you grow, you may embrace churn of smaller customers in favor of focusing on those that are the best fit. 

Accounts Receivable Turnover (ART)

What is it?

This ratio tells you how good you are at turning your sales into actual cash collected from customers. Your target ART ratio depends on your industry and specific business. A ratio of 12 may be a good target for a service business that collects monthly. Remember, trends are more important than the number itself!

Some (potentially) new terms

Credit Sales

Credit sales are those where the payment is not due in advance or on delivery.  Example terms include End of Month (EOM) and Net [# of Days] where payment isn't due until the end of the month or for a specified number of days.

For net credit sales, we just subtract any returns:

Accounts Receivable

Accounts receivable is the outstanding balance of all unpaid credit sales--goods or services that you delivered but the customer has not yet paid for.

To calculate your Average Accounts Receivable, simply average the outstanding AR balance from the beginning of the time period with the balance at the end of the time period:

Example

If we sold 25 of our margaritas on Net 7 terms, those 25 customers have 7 days to pay for their purchase.  Let's assume in those 7 days, 21 of the 25 customers paid their balance, leaving four who did not.

Net Credit Sales = 25 margs sold on credit x $10 unit price = $250

Average AR = ($250 AR at start + $40 AR at end) / 2 = $145

ART = Net Credit Sales / Avg AR = $250 credit sales / $145 average AR = 1.72

Why is it important?

What's it all for if you're not getting paid?! In all seriousness, problems collecting can lead to cash flow problems and lower profitability. There are a few different causes to low collections, which AR metrics can help you dig into.

If you have low or slow collections across all of your customers, you may need to revisit your collection process and policies. If you have a few customers that are outliers, perhaps they are struggling or might not be a good target customer for future business.

Inventory Turnover Ratio

What is it?

Inventory turnover is a measure of how quickly you sell your inventory and replace it with new inventory. A high inventory turnover ratio indicates you're selling inventory quickly, while a low ratio may indicate that you're holding onto inventory for too long. Understanding inventory turnover can help you optimize your inventory levels and improve your cash flow.

Example

Let's imagine we prebatched 200 margaritas at $3 each for an inventory cost of $600.  We know our COGS were $150 from earlier, giving us $150 / $600 = .25 Inventory Turnover Ratio.  in other words, only 25% of our inventory investment was monetized.

Now, let's imagine we reviewed our last 3 months of sales history and decided to only batch 55 margaritas instead of 200: $150 / $165 = .91 Inventory Turnover Ratio.  Monetizing 91% feels a lot better right?

Why is it important?

Stocking too much or too little inventory both have pitfalls. Understanding your inventory turnover can help you optimize how much inventory you keep on hand, which can improve your cash flow. Tracking your sales trends and inventory turnover both help you find your goldilocks level.