Sep

2

4 Critical Financial Metrics

Filed Under Finance 

    Just as you should check your vital signs of pulse, cholesterol, and weight on a regular basis, you should check your company’s vital statistics on a regular basis, and recommend a new course of action should anything be over or under what it should be. This article will consider the Vital Financial Statistics, also considered the Chi flow (or bloodstream) of the company - Revenue, COGS, Expenses, and Net Profit.

1. Revenue ($)

    Everything that puts money into the bank as a result of a product or service being sold. Needless to say, if you aren’t putting money in the bank, nothing else matters. Marketing and sales most directly affect this vital number.

2. Cost of Goods Sold aka COGS (%)

    The direct cost of selling the product or service. This amount includes the cost of the materials used in creating the good along with the direct labor costs used to produce the product or service. This should be measured as a % relative to the amount the product or service is sold for. As a conceptual example, you buy a trinket for $1 and sell it for $2. Your gross profit would be 50%. Operations most directly affects this number.

If you have a variety of products, then you will need to average out the COGS (remember to use weighted average).

eg, (Product 1 COGS * % of total Revenue) + (Product 2 COGS * % of total Revenue) + (Product 3 COGS * % of total Revenue.

 A corollary follows that Revenue - (COGS * Revenue) = Gross Profit.

Eg: It costs us 40c to make and ship 1 trinket. We sell it for $1. We make 60c gross profit (60% gross). It costs us $70 to buy one case of gift bags. We sell it for $140. We make $70 gross profit (50% gross). If in one month, we have 50% of sales revenue come from cards, and 50% of sales revenue come from gift bags, then we have an average gross profit of 60% for that month.

Most companies need a minimum of 50% gross profit to survive, and most regular retail operates on this sort of margin.  If you are in a sweet spot, you will have 70%-80% gross profit (essentially, a 300% - 500% markup)  Milk this for as long as possible!

3. Expenses ($)

Expenses can be divided up into two categories:

a. Fixed costs.

These are costs that vary < 5% on a month to month vasis, and typically include such things as rent, phone, salaries, etc. Things that are the basic necessities for a business to run.

b. Variable costs.

These are costs that may vary >= 5% per month, and include things such as marketing, computer equipment, legal fees, etc. Can be considered ‘reaction costs’, as each cost in this category is in response to a need in the company. For example, marketing is relative to the need for growth in the company. Equipment is relative to the need for operational efficiency in the company. Legal fees are relative to the amount of legal counsel required for a particular situation.

 

 

Equipment and computer purchases can be considered capital investments – moved to a balance sheet and depreciated over time, so are not necessarily included in COGS, Fixed Expenses, nor Variable Expenses.

4. Net Profit

The bottom line number. Consider this the heart beat. Once number this stops being positive, your company has a limited time to live. The amount of time it has to live is often called “the runway” - the amount of tarmac your plane (business) has to go before it takes off or crashes. Of course, with outside investment, this runway could be extremely long, buying you much more time.

Net profit = Revenue - (Revenue * COGS) - Expenses


With these numbers in mind, one can now forecast your breakeven and Net Profit projections by setting base premises and plugging into the equation. For forecasting, I typically create nine sample scenarios, holding Revenue, COGS or Expenses at a constant, and providing Bad, Neutral, and Ideal situations.

Here is an example with constant revenue and COGS:

Example 1 (conservative current)

Base premise #1: Revenue = $30,000.

Base premise #2: COGS = (45% COGS).

Base premise #3: Total expenses remain a steady $15k per month.

Net Profit = Revenue – COGS – (Fixed Expenses + Variable Expenses)

= $30,000 – ($30,000*0.45) – ($15,000)

= $30,000 – ($13,500) – ($15,000)

= $1,500

Example 2 (conservative current + COGS improvement)

Base premise #1: Revenue = $30,000.

Base premise #2: Gross Profit remains a steady 60% (40% COGS).

Base premise #3: Total expenses remain a steady $15k per month.

Net Profit = Revenue – COGS – (Fixed Expenses + Variable Expenses)

= $30,000 – ($30,000*0.40) – ($15,000)

= $30,000 – ($12,000) – ($15,000)

= $3,000

Example 3 (conservative target)

Base premise #1: Revenue = $50,000.

Base premise #2: Gross Profit remains a steady 50% (50% COGS).

Base premise #3: Total expenses remain a steady $15k per month.

Net Profit = Revenue – COGS – (Fixed Expenses + Variable Expenses)

= $50,000 – ($50,000*0.50) – ($15,000)

= $50,000 – ($25,000) – ($15,000)

= $10,000

Once the company is able to reach a profitability streak, the profit can then be reinvested into the company, taken out as income, or a mixture of both.  If it is reinvested in the company, be sure to calculate ROI on the investment and compare it to other personal investments (real estate, stocks, etc)

 Questions:

  1. Measure - Do you know your critical financial data?
  2. Assess current situation - Is it where you want it to be?
  3. Plan - To get to where you want to go, do you need to affect Revenue (sales & marketing), COGS (operations), or Expenses (operations, marketing, sales)?

Business Tip:  Create a check and balance system of verifying the measurements to detect early warning signs of error or fraud.

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