Now that we have proper financial information, let’s delve into how we measure performance across various aspects of the business. Maintaining accuracy and consistency is crucial. Each of these aspects hold its own significance, but they are all interconnected, forming a cohesive picture of the performance of the company.
- Gross Profit/Gross Margin – One of the most crucial metrics is Gross Profit/Gross Margin, which serves as a foundation for other key metrics, including Life Time Value (LTV) of a customer. Therefore, it is imperative to ensure the accuracy of your Costs of Goods or Services Sold (COGs/COS). One critical aspect in measuring gross profit is accurately tracking labor costs for the delivery of your product or service and properly allocating them to COGs. Proper labor cost tracking includes using fully burdened labor rates, allocating time spent on various activities such as implementation versus recurring services, and excluding costs that are not directly tied to delivering revenue. I often see companies making the mistake of including 100% of the delivery team’s time allocated to COGs, disregarding the fact that some of that time may be spent on product development, training, and time off. If you want to look at pure margins and understand where you have inefficiencies in your team, you will need to pull these costs out of COGs. Looking at the labor costs portion of COGs can provide you with multiple insights, such as the efficiency of your team, major time/labor drivers, team performance, and where you can invest in automation to decrease labor and improve margins.
- Categorizing COGs/COS for Deeper Business Insights – Further categorizing your COGs/COS allows for deeper insights into the various aspects of your business. I recommend tracking costs by product, type of service, delivery phase, or even by customer. Breaking down the different views of gross profit informs pricing decisions, reveals margins across different aspects of your business and provide you the insight to the different dials you turn to improve business performance. Determining what is reasonable and appropriate to track will vary based on your industry. However, at the very least, it is essential to examine Gross Profit/Margin in a more detailed view than what is presented on the surface of your P&L. Once you have a more detailed breakdown of your Gross Profit, you can start looking at comparative analysis of metrics such as LTV/CAC by product or service. This analysis will provide valuable insights to make informed decisions regarding where to invest in the company’s growth.
- Customer Lifetime Value (LTV) – In simple terms, the Life Time Value of a Customer refers to the amount of gross profit you generate from a customer throughout their entire relationship with your business. How much revenue will you get from them, if they are a subscription customer, will they have organic expansion, can you upsell their plan and when will they churn? If they are a service or CPG customer, will they make repeat purchase and how loyal will they be to the brand? Predicting churn, upsell conversion and repeat purchases can be both an art and a science. Segmenting your customers into cohorts of acquisition method and the product they purchased can provide valuable insights into their distinct behaviors and the LTV of each cohort. As a natural result, you will obtain better data for measuring renewal rates, expansion and customer retention.
- Sales & Marketing Data – There are many different metrics you can use to measure sales and marketing efforts, depending on your go-to-market strategy.For purposes of this article, we will focus on Customer Acquisition Costs (CAC). CAC represents the amalgamation of all sales and marketing efforts combined – the true costs of acquiring a customer. You can further breakdown CAC by properly tracking costs by acquisition channel and properly tracking new customer count by channel and/or product to arrive at CAC by channel and CAC by product.
- LTV/CAC ratio and CAC payback – The LTV/CAC ratio provides a direct picture of the return on your investment in acquiring a customer and is useful for industry comparisons. Additionally, CAC payback measures how long it takes to recoup the cost of acquiring a customer. Once you have a complete picture of LTV and CAC and are able to further break them down to cohorts, channel and product you can start performing more complex metrics to identify the highest returns from your sales and marketing efforts.
- Growth – Growth metrics should go beyond sales or customer count and include measurements across the Profit & Loss (P&L) statement in comparison to sales growth. Revenue growth should be broken down into new sales, existing customers, and expansion of existing customers, considering various periods such as monthly, quarterly, annually and trailing 12 months.
This list of metrics is not exhaustive but provides a good starting point to gain a deeper understanding of your business. Pulling these metrics together may require effort; having them correctly measured will allow you to evaluate different aspects of your business’s performance and set targets to improve that performance, which will be covered in part three of this blog series.
And if you missed it, be sure to check out Part 1: Understanding the Foundation of Financial Reporting.