Those of us trained in accounting love the details. We want every number to be perfect and need to know all the details about what caused a financial outcome to happen. But leaders don’t always need that level of detail to make great decisions.
The simplest framework I’ve come up with consists of just five numbers. Knowing these five numbers and how they are trending will give you a great overview of how your business is doing. Leaders can review these metrics quickly and dive deeper only if needed. Here are my “five to thrive” metrics:
Gross Profit: Revenue is vanity. Gross profit is the economic engine of your business. All the other metrics in your business should refer to gross profit rather than revenue.
Gross profit is all you have to pay your bills and return a profit to your shareholders. More revenue that delivers little gross profit does nothing but complicate your operation. Gross Profit = Revenue – Cost of Goods Sold (not including labor costs).
Labor Efficiencies: Labor is the largest variable cost in your organization after costs of goods sold. How efficiently that labor produces gross profit is the key to bottom line results in your business.
I track two labor efficiencies — direct and management labor. Direct labor is labor that goes directly into the product or service you sell. Management labor is all the rest.
I track direct labor against gross profit and management labor against gross profit after direct labor expenses are removed. Labor Efficiency = Gross Profit / Labor Cost.
Other Costs: You might have a few big sub-categories to track in your business but after labor and costs of goods sold most of your expenses are less controllable (think rent and utilities).
Make sure someone on your team owns each cost that you feel is worthy of breaking out into a sub-category and hold them responsible for predicting what that number will be each month.
Sales & Marketing Efficiency: Most small businesses underspend on marketing and struggle to calculate the return on investment of what they spend.
All the dollars you spend on marketing and sales should be measured against the gross profit after direct labor generated by that spend.
The lifetime value of a customer is the amount of gross profit after labor they will generate over their lifetime with your business. The sales and marketing dollars spent to acquire that customer is your cost of acquisition. Focus on lowering your cost of acquisition and maximizing the lifetime value of your customers.
Cash Flow: Cash flow is oxygen for your business and growing businesses burn through tons of cash. Profit does not matter if you cannot pay your bills. Know the cash conversion cycle for your business and strive to improve it every month.
You may feel that focusing on these five numbers is an oversimplification but give it a try. It will help your leadership and your team connect the work they do every day to the financial results of the organization. That connection will lead to improved decisions that drive better financial results. That is good for everyone.