Do You Know Your Numbers?

It’s surprising how many entrepreneurs are completely oblivious to the numbers that determine the health of their companies. There is a tendency for some business owners to continue to operate year after year, while hiding their heads in the sand when it comes to their finances.

Knowing your numbers is a vital component to building a successful and profitable business. When you have a clear understanding of your revenue, profit margin, and other important metrics, you are able to make better decisions, create accurate forecasts, and understand what’s working and what’s not.

The good news is that it only takes a small effort and a change in your mindset to get a firm grasp on the metrics that drive your business. And we are here to help! Let’s dive in and take a look at four key numbers that you should know.

@criene via Twenty20

Net Profit Margin

What percentage of your company’s sales is profit? When looking at the overall health of your business, your net profit margin is typically regarded as one of the most important metrics to consider. It represents how much of every dollar of sales is left over after deducting your expenses. Simply put, if your business generates $5 million in sales with $4.5 million in expenses, your net profit margin is 10%.

The average net profit margin varies widely depending on the type of business and many other factors. By measuring your net profit margin against similar businesses in your industry, you can begin to understand how efficiently you are running your company. If you aren’t measuring up to your competition, you can improve your net profit margin by making adjustments to your costs, pricing, and marketing.

Product Profit Margin

Do you know how much profit each of your products generates? If not, you are flying blind and merely guessing at important aspects of your business. But when you understand the profit margin of each product, you are able to approach your decision-making more strategically.

To determine a product’s profit margin, begin with the price at which you are selling the item. Then subtract the cost to make or purchase the product. This gives you your gross profit for the item. Finally, divide your gross profit by your sale price to arrive at the product’s profit margin. Exclude all costs that are not directly associated with the making or acquisition of the product. If you are a service-based business, you can use this same calculation for the services you offer.

When looking at the profit margin of each of your products or services, you are able to understand which items are most impactful to your bottom line. Would you make different decisions knowing your products’ profit margins?

Customer Lifetime Value (CLV or CLTV)

How much profit does an average customer generate for your business during the lifetime of their relationship with your company?

Chances are that you offer a range of products and/or services, all at different price points. Also, it is likely that you have customers who can be broken into different tiers, based upon the type of products or services they buy and the frequency at which they purchase them. For these reasons, it is wise to determine the CLV for each tier of customer. Based upon a customer’s buying habits with you and the average length of time you retain a customer, you can calculate a reasonable estimate of how much profit will be generated during the lifetime of each customer.

With this information, you can make better decisions regarding how much resources to dedicate toward servicing your customers and how much money you should be spending to acquire new customers.

Customer Acquisition Cost (CAC)

And speaking of acquiring new customers, how much are you spending to grow your base? Now that you’ve determined your CLV, you are on your way to calculating a reasonable CAC. Your sales and marketing budget should, in part, be based upon the amount of profit you can expect to generate from each customer.

Putting It All Together

Knowing your numbers is not just a fun exercise in mathematics, it’s essential to the continued success of your business. The more you know, the better equipped you are to manage and grow your company.

If you’d like to see an overview of your company’s overall financial health, you can take this five-minute business health assessment here.