If you follow professional sports, you know that you can’t just boil a player’s value or ability to perform down to a single statistic. One metric can’t reveal that much insight -- analytics is more complicated than that. It’s only when you examine numerous statistics or metrics together that you can get a full picture of a player’s ability to perform and truly gauge their value.
In business, the same principle applies. You can’t just use one metric to measure your financial performance -- that's way too limiting. To truly gauge your business' value, you need to track numerous metrics together to get a full picture understanding of your ability to perform.
In this blog post, we’ll cover the seven key metrics every business should track, allowing you to gauge your business’ performance from a more holistic point of view and measure your growth in a multitude of ways.
7 Key Metrics Every Business Should Track
1. Revenue Growth
Revenue is the amount of sales you generate by selling your product minus the cost of returned or undeliverable items. It’s the key metric every business uses to measure their financial performance. Obviously, earning the highest amount of revenue possible is ideal, but the metric that’s more indicative of your business’ financial performance is year-over-year revenue growth.
You must also remember that your business’ situation is completely different than your competitors’, even though you contend for the same customers. So it’s better to compete against yourself and compare your current revenue and revenue growth to your past financial performance than it is to compare it to your competitors’.
Otherwise, you could set a revenue or revenue growth goal that’s not attainable within your particular context, causing you to miss your goals, pressure your employees to cut corners in order to hit their numbers, and, ultimately, burn everyone out.
2. Average Fixed Costs
Fixed costs are your business’ costs that stay constant regardless if your business sells more or less of its product. For example, your rent on office space, website hosting costs, utility bills, manufacturing equipment, small business loans, property tax, and health insurance are all fixed costs because regardless of how much product you develop, ship out, and sell, these costs stay the same each month.
To determine how much your business will have to pay for each unit of your product before you account for the variable costs needed to actually produce them, you need to calculate your average fixed cost, which is your total fixed cost divided by your total number of units produced.
This will help gauge the level of impact your fixed costs have on your product’s potential for profit and how much you should spend on variable costs in order to turn a profit.
3. Average Variable Costs
Variable costs are the cost of all the labor and materials used to produce a unit of your product. Your variable costs directly depend on the amount of product you sell, so the more units you sell, the higher your variable costs, and the less units you sell, the lower your variable costs.
Some examples of variable costs are physical materials, production equipment, sales commissions, staff wages, credit card fees, online payment partners, and packaging and shipping costs.
To determine the amount of variable costs your business will have to pay to produce each unit of your product, you need to calculate your average variable cost. To do this, add each of your product’s unique total variable costs together and divide them by the total number of units of products made.
4. Contribution Margin Ratio
Contribution margin is calculated by subtracting the variable costs required to produce one unit of product from the revenue it generated. Since your variable costs are directly linked to producing your product and fixed costs are directly linked to keeping your business in operation and not producing your product, contribution margin helps you understand how profitable each of your products are.
But to truly understand how they individually impact your bottom line, it’s better to calculate each of your product’s contribution margin ratios. To do this, subtract each product’s total variable costs from their total sales revenue and divide that number by their total sales revenue. Your contribution margin ratio will be expressed in a percentage.
Once you know each of your product’s contribution margin ratios and, in turn, their profit potential, you’ll understand which products will generate more total profit if you produce more units of them, and which products will generate less total profit if you produce more units of them. These insights will help you develop a product mix capable of generating the highest level of profit for your business.
5. Break Even Point
Your business’ break even point is the quantity of product you must sell so that your total revenue equals your total costs. Knowing your break even point is crucial because it serves as the minimum goal your business should try to achieve in order to not lose money during a specific time period. Even better, if you surpass your break even point, your business will turn a profit during that time period.
To calculate your break even point, add up all your fixed costs and divide them by your contribution margin or the difference of your total sales revenue and total variable costs.
For example, if you sell baseball bats and your fixed costs are $500,000 and contribution margin is $50 for the year, you’ll need to sell 10,000 baseball bats to break even. If you sell more, you’ll turn a profit.
6. Cost of Goods Sold
Your business’ cost of goods sold is the cost of acquiring or making the products you sold during a certain time period, like material, manufacturing, and labor costs. In other words, they’re your cost of sales or cost of doing business.
Tracking your cost of goods sold, or COGS, is important because they directly affect your business’ bottom line. For instance, when your COGS increase, your profit will decrease, and when your COGS decrease, your profit will increase.
To calculate your COGS, you first need to pick an accounting method. Most businesses usually decide between three: First In, First Out (FIFO), Last In, Last Out (LIFO), and the Average Cost Method.
If you use the FIFO method, you’ll sell the oldest products you purchased or manufactured first. Prices tend to rise over time, so the FIFO method will allow you to sell your cheapest inventory, which will decrease your COGS and increase your profit.
If you use the LIFO method, you’ll sell the newest products you purchased or manufactured first. Prices tend to rise over time, so the LIFO method will allow you to sell your most expensive inventory, which will increase your COGS and decrease your profit, but you’ll also pay less taxes, which could help you offset or even overcome that initial loss in profit.
If you use the Average Cost Method, you’ll calculate the mean cost of your inventory, completely disregarding their purchase or manufacture date. This prevents periods of high inflation from influencing the cost of your goods sold.
7. Gross Profit Margin
Your gross profit is calculated by subtracting your COGS from your total revenue and reveals your business’ production efficiency or ability to optimize your material, manufacturing, and labor costs. However, since gross profit is a pure dollar amount and not a percentage of your revenue, it can increase even when your financial performance declines.
So to truly understand your business’ financial performance, it’s better to measure gross profit margin, which is your gross profit as a percentage of your revenue, instead of measuring gross profit. If your gross profit margin continues to climb over time, it’s a good indication that your business’ financial health is in good shape.
Tracking all of these business metrics can be challenging and time-consuming, but it's more than worth it to do so. Because, just like your favorite athlete, you don't want to boil your business's definition of success down to a single statistic. That's way too limiting. And, more importantly, it's not an accurate way to measure your business' value or financial performance.
Originally published Apr 3, 2019 11:45:51 AM, updated July 12 2019