In the crazy rush of running a business, it is easy to get lost in the smaller things. However, it is extremely important to often step back and evaluate how you’ve done so far. This post is about getting that yardstick in place by which you can measure yourself.
Many retailers out there might have this idea in mind that an increase in revenue could be taken as a solid indication towards a growing business.
Unfortunately, that’s not the case. An increase in revenue might not necessarily mean an increase in profit. But money is not all there is to it either. We’ve divided metrics into three sections:
- Operational Metrics
- Financial Metrics
- Customer Metrics
In the simplest of terms, these are ways to measure how effective your operations are. From inventory management to costs of running the business, these are numbers that arise from, and eat into, your profits. But even before we measure the metrics that have a direct impact on the profit, we need to know how to manage inventory effectively.
For every single product, there is such a thing as safety stock. This is the minimum number of items that you need to have in stock to avoid running out. The simplest way to calculate your required safety stock levels is by comparing the maximum sales to average sales over a period of time.
Say you have a very high turnover ratio, and you update your inventory each day. In this case, safety stock can be calculated using this formula:
Safety Stock= (Maximum Daily Sales X Maximum Lead Time) – (Average Daily Sales X Average Lead Time)
So what is lead time then, and why is it important? Say you have a manufacturer who can deliver a product in 7 days on average. Sometime, he takes 10 days and sometimes only 5. In this case, your average lead time for that product is 7 days and maximum lead time is 10 days. If you know the pattern of lead times over a month or a year, you can also calculate the average lead time as follows:
Average Lead Time (in a year)=(Lead Time in month 1 + Lead Time in month 2 +…+ Lead Time in month 12)/12
Inventory Turnover Ratio
This ratio tells you how many times your inventory was ‘turned’ or sold in a particular period of time. This tells you where you stand compared to your competitors.
Inventory turnover ratio is calculated as follows:
Inventory Turnover Ratio = Cost Of Goods Sold/Average Inventory Per Time Period
If you have a high inventory turnover ratio, that’s a good thing because it means one of two things. Either you have manages to keep the cost of goods sold high (you’ve sold more), or you’ve kept the average inventory over time low, hence saving on your capital.
If you want to understand inventory management in greater detail, this handy guide can help.
This is a pretty straightforward metric. Gross Profit tells you a simple ‘you sold this much and you made this much’, while Net Profit takes into account all the expenses and taxes you incurred in order to make that sale. Your net profit is the actual amount of money that you have made, hence, it is very important.
2. COGS(Cost of Goods Sold)
Having an idea of the total production cost of your company will tell you what you have to do exactly to increase your profit margin. In case your costs fluctuate over time, use batches to separate items or use standard accounting policies, like FIFO, to evaluate profits basis costs of items.
Also, if you’re not the manufacturer but only a procurer, your COGS would obviously be the Cost Price of the product plus the amount of money you spent holding it in inventory, plus expenses you incurred for making a sale. If you’re a manufacturer however, your COGS would also include the cost of raw material and manpower used to convert it into a finished product.
3. Expenses Vs Budget
Comparing your operational costs with your planned budget will show you the direction you are travelling in. This is a very important metric that will remind you if you have deviated from your actual plan.
Revenue is an actual indication of growth. If you are growing revenues along with profits, then you are growing a scalable business. If you feel that your revenue is growing but profits are shrinking, then you need to re-evaluate your unit-economics to figure out how to scale your business.
When we think of customer metrics, it may seem like n abstract concept, but it doesn’t have to be that way. There are ways to calculate customer metrics in a way that they make numerical sense.
1. CLV (Customer Lifetime Value)
Some customers matter much more than the others. As stated by the Pareto principle, 80% of the effects come from 20% of the causes. In business, this means that 80% of your success comes from 20% of your customers.
CLV(Customer Lifetime Value) is the total value that your business acquires from a customer for the entire time that he/she remains your client. This could include repeat orders, new customers you gained from existing ones and new business opportunities you got from them. You may have noticed that with apps such as Uber, you can get new people to sign up using your code, for which you both get free rides. But why does the company need to know how many new customers you to signed up. It is a measurable aspect of CLV, that’s why.
2. CAC (Customer Acquisition Cost)
CAC is the cost that you spend to win a customer. This cost involves all your marketing and sales campaigns, including but not limited to PPC advertisements and social media campaigns for online retailers.
A good ratio between your CLV and CAC should be 3:1. This means that your customer’s value over time is three times more than what you spent acquiring them in the first place.
Customer acquisition cost = Acquisition costs over a period of time/Number of new customer acquired in that period of time
3. NPS (Net Promoter Score)
NPS is considered as one of the most important growth indicators. It is important to send out quarterly surveys to your customers and analyse their responses. This way you will get a clear idea of what your customers really expect from you and where you have disappointed them.
“On a scale of 0 to 10, how likely are you to recommend our product or service to a friend or a colleague?”
How many such survey questions have you answered as a customer yourself? Based on your customer’s response, they may be classified into promoters, passives and detractors. Detractors are dangerous for business and they can influence people negatively, so you better get into their good books fast. Passives are neutral about you, so by demonstrating added value, you can convince them to become promoters. Promoters are happy to advertise your business positively, so you need to make sure they stay that way.
4. Repeat Buyers
To understand if you are delivering the right service to customers, check the percentage of buyers who buy repeatedly from you. Log into your CRM or order processing software and use a simple excel pivot table to get the frequency of orders by customers. A strong retail business makes at least 30% of it’s business from repeat customers every year.
While numbers alone can never determine the health of a business, they can surely help consolidate seemingly random data into numbers that make better sense.
What are some other metrics that you find yourself commonly using to get a sense of your business? Leave us a comment below!