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Profit and revenue tell you a lot about how your business is performing- but they don’t tell you everything.
Many businesses, here in Zimbabwe and elsewhere, have surprised their owners and external shareholders by collapsing soon after reporting increasing revenues and healthy profits. Bigger examples include Trust Bank, Renaissance Financial Holdings, and Jaggers while numerous small to medium sized businesses have gone bankrupt, as proven by the scores of firms appearing in the daily newspapers as they go under the hammer.
If you ask the owners of businesses that are suddenly in trouble, you will find that they believed they were making profit: taking out large sums of cash from the business (personal drawings), paying themselves high salaries and buying luxury vehicles and expensive gadgets- things that should be done only in highly profitable companies.
Unfortunately, because financial statements (if any are produced) only report facts historically after they have already happened, they do not provide early warning signs of trouble or indications of longer-term success. Here are four metrics that can help in this regard.
Cash Conversion Cycle (CCC). This is a metric that expresses the length of time, in days, that it takes for a company to convert resource inputs into cash flows. The cash conversion cycle measures the amount of time each net input dollar is tied up in the production cycle and sales process before it is converted into cash through sales to customers. It measures the time needed to sell the inventory and collect the payments.
A high or rising CCC is a sign of a deteriorating cash flow position, especially if your time that you are afforded to pay your bills without incurring penalties is short or decreasing.
Cost to Acquire Customers (CAC). Also known as customer acquisition cost, this measures the cost of landing a customer. In simple terms, add up the cost of marketing and sales—including salaries and overhead—and divide by the number of customers you land during a specific time frame. Spend $100 and acquire 10 customers and your CAC is $10. What’s a good number? That depends on your industry and business model. It’s also important to understand how CAC fits into your overall operating budget. The leaner your operation the more you can afford to spend to acquire a customer.
Also keep in mind that a high CAC makes sense if you also generate a high LTV.
Lifetime Value of a Customer (LTV). Unless your business is truly one-off, some percentage of customers will become repeat customers. The more repeat customers you have, and the more those customers spend, the higher CAC you can afford. (Some business models are built on breaking even on the customer’s first purchase; future purchases will be profitable since the CAC is at or near zero.)
LTV is often tricky to calculate and does involve making a few assumptions, at least during the startup phase. But once you’ve built a little history you can start to spot customer retention and spending trends. Then the math gets a lot easier: Determine what the average customer spends over a specific time period and calculate the return on your original CAC investment. Sense-check that against your profit and loss statement. Roughly speaking, the greater the LTV, the higher CAC you can afford.
Why do these two metrics matter so much? A rising CAC means you’ll need to start cutting costs or raising prices—or do a better job in marketing and sales. A falling LTV indicates the same measures are necessary… and means you’re failing to leverage the most important and least expensive customers you have: current customers.
Churn rate. Every business gains and loses customers; that’s a fact of business life. But still, lost customers are like failed investments. You spent money to acquire them, service them, and try to retain them… and now they’re gone.
A rising churn rate could be caused by a number of factors: Dissatisfaction with your products and services, new competition in your market, or even the coming end of a product or service cycle.
Churn rate is a solid indicator of rising CAC and lower LTV. In fact, all three are great leading indicators of problems—or successes—to come, both in other metrics and for your business overall.
Revenue percentages. Very few businesses only have one source of revenue. Most have multiple sources and changes in the contribution percentage each makes can indicate problems are ahead.
Take business plan consultancy, a business I know something about. To keep things simple, say 50 percent of revenue historically comes from the initial business plan package sold to entrepreneurs and potential business owners. 30 percent from company registrations and business set-up consultancy after the venture gets off the ground and 20 percent from post-start up consultancy, such as taxes, bookkeeping etc. If post-start up consultancy fees fall off that will impact overall profit levels since almost all marketing and sales costs go into attracting business planning clients, so margins on additional sales are naturally much higher.
Changes in revenue percentages can often signal not only changes in customer spending habits but also broader trends in your industry and market.
If you have other key metrics your business follows, share them by emailing them to the publisher, firstname.lastname@example.org.