How can you be sure your business is successful? Increases in web traffic, high social media engagement, and positive customer reviews are all good indicators that your business is reaching new audiences and building a strong reputation. But even popular businesses can still be unprofitable.
Customer engagement metrics are important but subjective. And they’re only one piece of the profitability puzzle. To find out if your business is truly successful, you’ll need to track money metrics. These financial performance indicators allow you to chart your business success objectively over time. Plus, knowing where your business stands financially on a given day helps you make smarter financial decisions, like where to best focus your investments.
In addition to tracking your 5-star reviews, these are the 5 key performance indicators you should be tracking to ensure your business is on the path to profitability.
From gross profit margin to customer churn rate, get a guide to the key financial indicators you need to know.
1. Gross profit margin
To start, you’ll want to know exactly how much of your revenue is profit after factoring in the cost of production, including materials, labor, and overhead costs related to production. That’s where your gross profit margin comes in. To find your gross profit margin, you’ll first need to calculate your cost of goods sold (COGS).
To calculate your cost of goods sold, choose a time period to look at. If you have a year’s worth of data, use the full year. Add the cost of inventory at the beginning of the year to inventory purchases made throughout the year. Then, subtract the cost of inventory remaining at the end of the year. The result is your yearly COGS.
Once you have that number, calculate your gross profit margin by subtracting the cost of goods sold from total revenue and dividing the result by total revenue. The equation looks like this:
(Revenue - COGS) / Revenue = Gross profit margin
Your gross profit margin ideally should be large enough to cover your operating expenses while leaving you with a profit. As a rule of thumb, your gross profit margin should be at least 10% — but profit margins vary by industry.
Take this metric one step further by calculating your net profit margin. Your net profit margin accounts for all expenses, not just production costs. If your net profit margin is significantly lower than your gross profit margin, it may be an indicator that your non-operating expenses are a bit too high. To find your net profit margin, substitute total expenses for COGS in the equation above
2. Accounts receivable turnover ratio
Your business may be making sales, but if you’re not collecting cash from credit sales in a timely manner, it could be hurting your cash flow—or worse, your profits. Understanding your accounts receivable turnover ratio helps you understand how well you collect cash from credit sales—in other words, how quickly your customers pay their credit debts.
To calculate your accounts receivable turnover ratio, you’ll need to know your net credit sales and average accounts receivable value. To find net credit sales, subtract returned items from your total sales. To find your average accounts receivable value, choose a time period to calculate, add your beginning balance to your ending balance, and divide the total by 2.
The formula for calculating accounts receivable turnover ratio looks like this:
Net credit sales / Average accounts receivable = Accounts receivable turnover ratio
A higher ratio indicates that your customers are paying faster, accelerating your cash conversion cycle—but this ratio varies by industry.
It’s possible to have a high accounts receivable turnover ratio but still have some late-paying customers. For this reason, it’s important to check your aging accounts receivable report to track unpaid customer credit memos and invoices on a regular basis. Invoices with clear payments terms and flexible payments arrangements can help you get paid faster.
3. Customer acquisition cost
Every successful business has one thing in common: customers. But if you’re spending more money acquiring customers than those customers are spending in your business, you may be losing money overall. Understanding your customer acquisition cost (CAC) helps you determine if you’re getting your money’s worth out of your customers.
To calculate your CAC, add up all the costs associated with acquiring new customers within a chosen time frame. This includes marketing materials, paid social media campaigns, pay-per-click advertising, and labor costs for your marketing team. Then, divide that amount by the total number of customers you’ve acquired within the same time frame. The equation looks like this:
Total customer acquisition costs / Total customers acquired = Customer acquisition cost
As always, customer acquisition costs vary by industry. Spending $50 per new customer acquired might feel high for some businesses, but low for others. Understanding where your own customer acquisition costs land on that spectrum comes down to knowing the value your customers bring to your business.
For example, if you know your CAC is around $50, but customers tend to spend less than $50 in your business, you’re losing money. On the flip side, if customers tend to spend closer to $100 in your business, that’s a gross profit of $50. Calculating your customer lifetime value can help you determine if your customer acquisition costs are too high or just right.
4. Customer conversion rate
If your customer acquisition costs are higher than you’d like them to be, looking at your customer conversion rate is a good first step. It answers the question “how many prospects are you reaching that don’t actually convert to paying customers?”
Depending on the type of business you run, there are a few different ways to measure your conversion rate. If you have an online business, you can divide the total number of purchases made within a specific time frame by the total number of unique visitors to your website within the same time frame. For example, if 5,000 people visited your website last month and 500 made a purchase, your conversion rate is 10%. In general, the formula looks like this:
(# of people who made a purchase / # of visitors) X 100 = Customer conversion rate
However, your conversion rate doesn’t have to be measured in visits and purchases, you should use whatever metrics make sense for your business. For example, you can track how many prospects see a social media ad and make a purchase from the ad. Or how many people receive an email and click on the call to action within the email.
5. Customer churn rate
Of course, converting prospects is only half the battle. Retaining customers who have already made a purchase is just as important. That’s where your customer churn rate comes in. Your churn rate measures how frequently customers stop buying your products or services over a given time frame.
To calculate your customer churn rate, choose a time frame (usually one month). Subtract the number of customers you have at the end of the month by the customers you had at the beginning of the month. Then, divide by the number of customers you had at the beginning of the month. The equation looks like this:
(Customers at the beginning of the month - Customers at the end of the month) / Customers at the beginning of the month = Customer churn rate
A low churn rate is an indicator that your customers return to your business time and time again, increasing their lifetime value. A high churn rate may indicate that you need to spend more time and effort nurturing the customers you already have. If you end the month with more customers than you started with, it means you’re adding new customers faster than you’re losing them.
Choosing the right money metrics
Here’s a confession: This list isn’t totally comprehensive. It can’t be. There are a huge number of financial performance indicators you could track for your business and even more ways to use them.
You can compare these numbers against each other to gain a deeper understanding of how they impact your profitability. You can track them over time to see how your finances grow or change, so you can more accurately forecast financial events and plan for the future. And you can use them to objectively measure the financial success of your business—no matter how many social media followers you have.
But what you can’t do is track every single key performance indicator. You have to choose the metrics that make the most sense for your business goals. At the end of the day, the most useful metrics help you measure what you deem most important for your business.
Tracking made easy with QuickBooks + Amazon Business
If you’re not a math whiz (you’re not alone, lots of small business owners aren’t confident with the financial formulas that come with running a business), these equations can look pretty overwhelming. But generating financial reports and running the numbers is easy when you use accounting software like QuickBooks Online.
QuickBooks tracks transactions and accounts automatically, so you always know where your money is going (and where it’s coming from). Plus, automated reports give you a clear view of your money metrics and profits over time. And when you make business purchases through Amazon Business, the Amazon Business Purchases app imports transactions to QuickBooks automatically. It’s a smart and simple way to track the money metrics that matter.
This app only works with Amazon Business accounts. Sign up for a free Amazon Business account account to access a wide selection of products and tools for your business.
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