Monday, May 26, 2014

Getting Your Business Numbers Right

A lot of entrepreneurs only bother about their detailed business numbers and financials when they need a bank loan or an external fund. They seldom see the need to be on top of their business numbers at all time.

In today's special post, I will show you the business numbers that matter a lot and that you have to get right always.

1. Operating Profit
If you have ever looked through a financial statement or had to make a detailed financial plan, then you would have come across the words COGS and SGA. COGS stands for cost of goods sold. If your are in the manufacturing industry and you buy N5,000 worth of raw materials to make each unit of your finished product. Your COGS is N5,000 per unit product sold. SGA stands for selling, general and administration. If it costs you N1000 to get each product to a buying customer (this will usually include the costs of advertisement, company administration, payroll and other general expenses that can't be classified under COGS) then your SGA is N1000.

Usually, you can't influence your COGS (much). The price of your raw materials are outside your control and often the maximum you can do is to negotiate for a discount. But you can always influence your SGA. In the case of the manufacturing company above, you spend N1,000 to make a sale. The only way your company can grow is if you are able to make enough gross profit to cover this cost. You will have to sell your finished product for above N6,000 or bring down your SGA cost (but still sell well above N5,000). Otherwise, you'll soon be out of business.

The trouble is most businesses don't compute their actual SGA. They often deduct the COGS from revenue to compute profit, but that is called gross profit, not operating profit. Operating profit is Revenue - (COGS + SGA). They only look at their company bank statements to make estimates of operating profit.

If you are a small business, I will recommend you use QuickBooks to track all your expenses and compute your SGA.

2. Cost of Acquiring a New Customer
This is the amount you spend to convince someone in your market to buy your product/service and become a customer. It will involve cost of marketing, incentives/promo and research. This business metric is very valuable. It helps you to properly consider if a new market or a particular customer is worth the cost. Not all customers are equal. If you know your current cost of acquiring a customer, then you will know when to stop spending to get a particular customer. You will be able to avoid spending too much on one customer to the detriment of other customers you could acquire for less.

3. Customer Lifetime Value
Once you're in business for a considerable length of time, a pattern begins to form. You'll begin to notice that some customers keep buying your product/service and some only buy once. One metric you should begin to compute when that pattern seems steady is your customer lifetime value. It is the net profit you make from your average customer. And it is also the upper limit to the amount you can spend to acquire a new customer. 

Every one of your marketing strategy, especially promo, should be built with this number in mind.

4. Inventory Turnover
This is the ratio of your sales to inventory. It is practically the number of times your inventory is sold in a specific time period (usually a year). If you have a stock of N1 billion naira inventory but only manage to sell N10 million naira, then something is wrong. You are incurring a lot of inventory storage cost and the risk of having an obsolete inventory. You should reduce your inventory to less than N50 million naira at a time so you can have enough for your sales and not too much to incur unnecessary costs and risks.

And if you sell perishable goods or seasonal goods, you should keep the ratio close to one. 

Depending on the size and type of your business there are several other business numbers you need to get right.

To your success!