Choose a manageable number of key metrics that help you tell an intuitive story about your business.
No matter what kind of business you manage, you’ll need to take a step back and take stock of your performance from time to time. The most objective way of doing that is to measure your performance quantitatively and to track those key performance indicators over time.
Don’t lose track of the forest for the trees, though. There are countless KPIs and financial ratios out there, but calculating and tracking as many of them as possible isn’t going to help you very much. Instead, start out tracking a manageable number of them, and choose the ones that help you tell a story about your business.
To start, we suggest making sure that you always know the following about your business:
At the end of the day, if you don’t have customers, then you don’t have a business. When starting up, acquiring customers is the name of the game, and every new customer gained is a huge win. Keep track of the aggregate number of customers you served in the last month, and also try to determine how many of those customers were returning customers as opposed to new customers.
Even after you’ve been in business for a while and your business has stabilized, understanding the scale of your customer base is an important part of understanding your business. Does your business serve only a very small number of customers per month? If so, then they’d better be spending a lot of money on your services per month. Or does your business serve a very large number of customers per month? If so, then a small amount spent per customer may still be sufficient to meet your revenue goals.
All right, so customers are making it through the door? Great! Now make sure that they’re actually giving you enough of their money after they do. Remember that all the cost-cutting in the world isn’t going to get you anywhere if you don’t have enough revenue coming in in the first instance to keep your business afloat, so focus first on getting your revenue where it needs to be to support the business and then watch it like a hawk. You should have an intuitive sense of when and where you expect revenue to show up. Some businesses are highly seasonal, and others are nothing if not consistent, day in and day out. Where does yours fall on the spectrum? Make sure you have a good grasp of what you should expect in terms of revenue and then watch for any surprises. Unexplained changes in revenue, especially of the downward kind, are early warning signs, so don’t let them go unheeded.
But keep in mind that your customer base is never static. Some of your customers may be repeat customers who keep coming back to buy your services over and over again. Repeat customers are great because the easiest customer to get is the one you already have. You don’t need to keep spending as much in marketing dollars on this customer because they already know who you are and what you sell and they like it. You can also think of repeat customers as representing a vote of confidence in your business from the market.
Determining how many of your customers are new customers each month is helpful because it will allow you to calculate your customer acquisition cost. You simply add up all the money you spent on marketing and sales activities in the last month and then divide that number by the number of new customers you acquired. The more customers you acquired, the lower your customer acquisition cost will be.
A lot of businesses don’t think to track this metric, but they really should. The reason isn’t obvious up front, but it sure is once you hear the explanation: If you’re spending more to acquire each customer than that customer is going to pay you in revenue, then you’re going to go out of business. Avoiding that fate means that you’ll need to keep your customer acquisition costs below what we call your average customer lifetime value.
But before we even get to that point, just track your customer acquisition cost and see if you can break it out by marketing channel. Lots of businesses will ask in surveys how you heard about them, and doing so lets them determine which marketing channels are the most cost effective at bringing in customers. If a particular channel is really expensive and doesn’t bring you many new customers, then get rid of it! Shift your marketing dollars somewhere where they’ll do more good.
Not everything you can measure is the type of thing that will always put a smile on your face, but you have to measure them anyway. One of those Debbie-Downer metrics is customer attrition, also known as churn, but it’s better to face it and know what it is than to put it out of sight and out of mind.
For some types of businesses, like those with subscription-based revenue models, measuring churn is easy. When the customer cancels their subscription and stops paying, you know right away that they’ve churned out of the system. Lots of businesses, from your local gym or yoga studio to your humble small business software-as-a-service startup--*ahem*--use this model.
But many businesses don’t have that luxury. For example, your local microbrewery probably operates primarily on a point-of-sale model, and they may have to get more creative if they want to track customer churn. Point-of-sale software may make it possible to capture the number of times a credit card payer has visited the bar before and how frequently, which may provide a basis for determining that the customer won’t be coming back if they haven’t been in for an uncharacteristically long time. The results may not be perfect, but in this space, educated guesses will be better than nothing.
Obviously, a high degree of churn is cause for alarm. However unpleasant it may be to face the numbers here, do yourself a favor and keep a close eye on churn and use it as a warning signal so that you know when to change course.
“Umm, profit? When are they going to talk about profit?” Finally, at long last, we’ve come to whole reason why you got into business in the first place. Once you’ve attracted a critical mass of customers, you’re earning revenue, your attrition rate is low, and you’re making more money on each customer than you’re paying to acquire them, start paying closer attention to the net income line on your income statement. You may not be in the black as soon as you start your business, but after focusing on the above metrics for a while, you should get there soon enough.
Net income, as you probably already know, is the bottom line on your income statement and is the difference between your revenue and all of the various expenses and tax that you have to pay. If you have an accountant, then ask them to spend a little time with you on the income statement. It isn’t just a report to prepare so that you can file your taxes. It breaks out your expenses into different line items, and an analysis of each one can tell you where the weak spots in your business are. If your gross margin is low because your cost of goods sold is high, then you’ll want to think about finding better-priced inventory, reducing the amount of inventory you keep on hand, or increasing the rate at which you turn over your inventory. But if your operating margin is low because your sales, general, and administrative costs are high, then you’re going to want to focus on efficiency in the back office and marketing areas.
Still have your accountant on the phone? Good, then ask him to help you calculate your cash conversion cycle. This calculation gets a little tricky because it relies on a couple of accounting metrics: days inventory, which tells you how many days on average inventory sits on your shelves before you sell it, days payable, which tells you how many days on average it takes you to pay off an account payable, and days receivable, which tells you how many days it takes you to collect receivables from your customers.
Essentially, when you add days inventory to days receivable and then subtract days payable, you get a sense of how many days you need to finance the inventory you hold. If you have a long cash conversion cycle, then you’re going to want to look into financing options like inventory financing or a more general line of credit so that you’ll have the cash to pay your suppliers while you wait for your customers to pay you.
Once you’ve gotten a handle on your financing needs, make sure you closely monitor just how much financing you’ve taken out. An easy way to do this is by calculating your current ratio and your quick ratio. The current ratio is just equal to your current assets divided by your current liabilities. The more you have in current assets--i.e., those that you reasonably expect to reduce to cash within the next year--relative to your current liabilities, the more breathing room you have in dealing with your lenders.
And if you want to be more conservative, then you can calculate your quick ratio, which is equal to the sum of your current assets (other than inventory) divided by your current liabilities. We exclude inventory from the quick ratio because you’d have to go through the trouble of selling the inventory to get cash for it, and a business that held inventory on hand for a longer period of time might not want to do that all at once to avoid taking a haircut in a fire sale. (The slower you turn over your inventory, the more important the quick ratio will be to both you and your lenders.)
The current and quick ratios are important to monitor because you always want to know just how concerned you need to be about making your debt payments to your lenders. Lenders always want to get their money back, and they’re entitled to get it back before you get to take any distributions on your equity. That sometimes makes for uncomfortable conversations when lenders get worried about the safety of their loans. Make sure you know how much you have outstanding relative to your ability to pay so that you don’t get into trouble.
Most of the other metrics we’ve discussed are accounting metrics, but this one’s a little different. Customer feedback will generally come to you either directly, through a third-party, online aggregator like Yelp! or a social media platform, or in response to a direct solicitation that you send out. Look for feedback on any existing, third-party websites like Yelp! right away so you know what’s out there, and then go one step further and start asking your customers for feedback. It can yield some very valuable lessons.
Keep in mind, though, that customer feedback can be something of a mixed bag. Sometimes customers will leave you reviews that are really positive but also don’t say much of anything that you can use to improve your operations. Certainly, you’d rather hear good feedback than bad, but a lot of successful business owners just want to know what they could be doing better so that they can keep improving.
On the flipside, sometimes customer feedback can be really tough to face because sometimes you’ll have to hear things you don’t want to hear. If you aren’t giving your customers what they want, then at least one of them will tell you about it, and they won’t always be nice about it. Don’t blame the messenger for delivering a message poorly. Treat the feedback as an opportunity to improve and then see if your feedback improves in the future.