Know Your Numbers
17 Numbers that Determine Your Business Success
I LOVE numbers. Here’s why. Numbers are objective. They have no emotion. They have no viewpoint. Numbers never lie.
As a business owner, you must know your numbers. In this post, I will convey seventeen numbers in your business that you must know. I'll show you how they are calculated and how they drive your business. If you learn these business numbers, you will intuitively know where your business is going and know how to create unlimited success.
I view businesses as a sequential machine. When I coach a starting business owner, I help them create a business plan. The first part of that planning process is creating a financial forecast. Yes, we start with numbers.
The sequence of this machine goes like this: 1) Marketing; 2) Selling; 3) Direct Costs; 4) Pricing; 4) Forecasting; 5) Staffing; 6) Expenses; 7) Profitability; and 8) Investment. This sequence is exactly how I help business owners plan their finances.
You have a product or service. There are specific people who want or need that product or service that you want to provide. There are other players in this market trying to do the same thing as you. This is your future competition. The combination of your competition and your prospective customers is your marketplace.
The first number you must consider is the total market share that you hope to gain by your business and how long it will take you to gain that business. In many cases, these numbers are a complete guess. In some cases, you may be able to back up these numbers in more material ways. Especially, if your business has been in operation for a certain amount of time.
Marketing is your ability to gain leads for your business. A lead is attracting a buyer in your marketplace to your company, product, or service. The way that you attract leads is that you invest in marketing or advertising. This marketing effort takes many forms. It can be Google Ads. It can be in-person networking. It can be mass media advertisements on TV or Radio. It can be a billboard on the main highway. It can even be word of mouth.
The second number is the amount of money you invest in marketing divided by the number of leads you gain. In simple terms, this is called your cost per lead. If you pay $5,000 per month in internet ads; and you get 10 leads, your cost per lead is $500.
Once you have attracted a prospective buyer to your company, you must convert that interested buyer into a customer. This process is called selling or sales. Like marketing, selling happens in a variety of ways. Your prospect may read some convincing text on your website, click a button, and give you their credit card information. Voila! A sale. Or, you may use a team of sales people who walk your prospect through an educational sales process which concludes with a successful sale.
The third number you must know is your sales close rate. The sales close rate is the percentage of prospects who enter your sales process as leads and end up as paying customers. If you gain 10 leads and 6 of them make a purchase, your close rate is 60%.
The fourth number that you must know is the cost of sales. In most cases, the cost of selling is the same whether a customer buys or not. This means that your cost of sales should be calculated as a cost per lead. If you spend $10,000 on the ten leads you obtained, your cost per lead is $1,000.
This brings up the fifth number you must know. It is your cost to acquire a customer. This is your marketing and sales cost combined divided by the number of successfully closed customers. If 6 customers make a purchase, and you spent $10,000 on selling plus $5,000 in marketing, your cost to acquire a customer is $2,500 ( [$10,000 + $5,000] / 6 ).
The sixth number is your sales cycle time. Long sales cycles can be 1 to 2 years; while short sales cycles will be 1-day. The time of the process is dependent on the complexity of your sale. Shorter sales cycles are often referred to as transactional. Longer sales cycles involve a lot of education, investigation and are often associated with solution-based selling.
For our example, let’s say that a successful sale happens in an average of 1-month.
Direct costs go by many names. They may be called Cost of Goods Sold (COGS); or Cost of Sales (COS). A direct cost is any cost that can directly be attributed to the product or service being sold by your business. Let’s say that your business is a car wash. The direct costs for your car wash will include soap, water, car washing labor, and any other consumable item it takes to wash cars. The idea is that your direct costs will rise or fall with the number of cars you wash. This applies to any other type of business as well.
This seventh number of importance is to assign direct costs associated with your products. This will vary widely based on your business. For a restaurant, direct costs include the food cost for each menu item. While it’s true that the time the chef takes to make the meal, the time the dishwasher takes to wash the dishes for the meal and the time the server takes to serve the meal can be thought of as direct costs, they are not considered direct costs because it’s too darn hard to estimate these labor costs for each meal served.
Continuing with our example, let’s say that it takes 100 hours of a technician’s time at $30 per hour plus another $5,000 in material costs for the widget you sold. You also pay your salesperson a commission of $1,500 per widget sold. This means that your direct cost for this item is $9,500 ( [$30 x 100] + 5,000 + $1,500 ).
Your service price is what you will charge your customer to perform the service work; or it’s the price the customer pays for your product. At this point, your numbers become a little more interactive.
In the previous example, you estimated the direct cost for your product at $9,600. I coach most of my clients to double their direct cost to yield their price. In this case, that would mean a price of $17,200. This is your eighth number…. the price.
The ninth number is your gross margin per product. Gross margin is your price minus your direct cost divided by the price. In our example, the gross margin is 50% ( [$19,000 - $9,500] / $19,000 ).
You create a price list using this pricing process that lists all your products and services. The interactive nature of pricing means that you check your prices against your competition. If your competitor’s prices are lower, reconsider your direct costs or highlight quality differences in your product or service vs your competition. If your competitor prices are higher, double check that you have adequately counted your direct costs.
Forecasting is predicting the quantity of sales on a monthly or yearly basis. If you sell coaching sessions, you will predict how many coaching sessions you sell each month. This number is tied to the sales funnel that we described previously. If you have an established business, you may have a good idea of your sales and marketing success. However, if you’re a new business, you are guessing at your sales and marketing success. Therefore, the factor that drives this forecasting number is the amount of money you want to place at risk in sales and marketing.
In our example, the marketing budget is $5,000 per month. This marketing budget is expected to generate 10 leads. To process these ten leads through your sales process it will cost you $10,000. If your sales process takes a month. Then your forecast will lag the investment in marketing and sales by one month.
You will invest $15,000 in the first month to get six sales in the subsequent month. If you want to grow the number of sales you receive, you will need to increase your sales and marketing budget by an appropriate amount each month. The cost to acquire a customer was calculated to be $2,500. This means that you will increase your sales and marketing budget in your forecast by $2,500 each month, if you want to grow your business by one additional customer each month.
This tenth number is a series of numbers called your item forecast. In my financial forecasting tool, I show the monthly sales and marketing budget growing while the item quantities grow each month for an entire year.
Staffing is the number of people you must employ in your business, the type of staff members and timing. The numbers of people are tracked in Full Time Equivalents or FTE’s. One FTE is a full-time employee.
There are three basic types of staff you will hire.
Direct Cost Employees: The first of these is your direct cost employees. These are the employees who you hire based on total sales. This is the eleventh number. The number of direct cost employees is calculated by the number of items in your item forecast. In our example, I estimated that your business required 100 technician hours for each item sold. If you sell 6 items, then you need to have 600 technician hours. The average amount of time an employee works in a year is 1,896 (52*5*8 – 80 vacation hours – 88 holiday hours – 16 sick day hours). Therefore, one FTE in a month is 158 hours. If you sell six items, you will need 3.8 technician FTE’s to deliver on the items you’ve sold. It will be wise to hire 4-FTE’s for this first month. In subsequent months, your FTE’s will grow as your item sales grow.
Sales & Marketing Staff: The second type of staff is sales and/or marketing people. These folks will be included in the sales and marketing costs that you had estimated in the marketing and selling sections. In our example, marketing was purely an investment in internet ads; so there is no marketing staff in our example. I estimated that it would cost $1,000 per lead to work with the ten leads you gained from your marketing effort. This effort is based on people. Your twelfth number is the number of sales and marketing staff. Let’s say that you pay your salespeople $2,000 per month in base compensation plus a 10% commission on sales. The sales commission is already counted in the direct costs (some do not count commissions as direct costs). To calculate the number of sales staff, divide the total cost of selling by the base compensation you pay your salespeople ($10,000 / $2,000). This means you will need five salespeople to gain six customers in your first month and more as you grow your business.
Indirect Staff: Indirect staff are the people you need in your business that do not directly associate their time with earned revenue. This will include managers who are not assigned to projects or work output; administrative assistants, bookkeepers, and any other support staff required for your business. Unlike the other staff, this staff is not based on any formula from items sold. In startup small businesses it is common for the business owner to fill many of these roles until revenue is sufficient to justify hiring part-time or full-time indirect staff. The thirteenth number is the number of your indirect staff. In our example, we’ll add in an administrative assistant at $40,000 per year; and a CEO (possibly you) at $85,000 per year as indirect staff.
Wages: I’ve alluded to wages in the previous numbers. However, each staff member must have a specific wage. This is the fourteenth number… or set of numbers. Some of your employees will be paid hourly while other employees will be paid an annual salary. Ensure that you include loaded costs in all your wage calculations. A loaded cost means that you are considering benefits, vacation time, holiday time, sick time, health insurance, 401k matches, and added payroll taxes you must pay as an employer. In a previous example I estimated that the technician costs $30/hour. Your cost of $30/hour as an employer will translate to $23.50/hour paid to the employee. By the time the government gets their share of the employee’s paycheck, the employee will receive $20/hour. You will need to determine what benefits you will offer, how much paid time off you give your employees, to ensure you are properly accounting for wage costs in your financial forecast. In the case of salaried employees, you don’t need to go through the gyrations of holidays, sick days and vacation. However, you must add benefits and employer paid payroll taxes.
The fifteenth number is expenses. Expenses are costs of your business that cannot be assigned to specific work output. Expenses often include office lease payments, accountant fees, office supplies, insurance, business coaching fees, training, and other costs. Indirect staff, sales, and marketing costs that we’ve already discussed are part of your expense budget. In our example, let’s say that your expenses are $30,410 per month ($15,000 for sales and marketing costs + $5,000 for general expenses + $10,417 for indirect staff).
The sixteenth number is profit. Profit is your gross profit minus your expenses. If this number is negative, it is called a net loss.
Let’s see how profitable our example business is running.
In the first month, you will spend $30,417 and not get one penny in revenue. Why? Because it takes your salespeople a month to close a sale. Therefore, you will lose $30,417 in your first month.
In the second month, you have six new customers who result in revenue of $114,000. You hired four technicians that month that cost you $4,780 each for a total of $19,120. You had to purchase $30,000 in material costs for your six customers. Your total direct costs for your six customers is $58,120 ($30,000 + $19,120). Your gross profit for that second month is $55,880 ($114,000 - $58,120); or a gross profit percentage of 49% ($55,880 / $114,000). When you subtract your monthly expenses of $30,417, your net profit is $25,463 or 22.3% of revenue. You almost made enough money to pay for your loss in the first month of operation.
The number one reason that most businesses fail is that they run out of cash. Based on our simple example you can see how that happens. Let’s say that your salespeople don’t close six sales: and only close two or zero. This creates month after month losses. Even if you’re successful, it may take a few months or years to grow your business to a point where it starts putting cash back in your bank account.
Whenever you show a loss, that means someone will need to pay that cost. The business owner can pay for small losses but will need investors to help with large negative cash flows.
The seventeenth number is investment. A new company will struggle to get investors to invest because they do not have a proven business model. Investors know better than to invest in an unproven business. As you can imagine, investment is NOT a one-way street. An investor wants to receive a multiple of their initial investment in return.
There are two types of investment: 1) equity; and 2) a loan. Equity investors will give you money hoping that your company grows in value and pays them dividends when the company is profitable. A loan is given by a bank with the expectation that you will pay back the loan with interest.
The forecasted profit and loss from my business financial planning tool shows how our example company will operate for its first five months in business.
You can see that our example company needs investment for its first few months and breaks into the black on its third month. … making money the rest of the months. I a real scenario, it will take longer to get traction in your business; and with growth, your cash flow will not look as attractive in the short term.
Let’s recap… Here are the seventeen numbers you must know in your business.
Cost per lead
Sales close rate
Sales cost per lead
Cost to acquire a customer
Sales cycle time
Direct cost by product/service
Gross margin per product/service
Direct cost FTE’s
Number of Sales & Marketing Staff
Number of Indirect Staff
Wages & Salaries
Wow! That seems like a lot… but it’s not. There are seventeen numbers that you must understand with your business. If you understand these numbers, you will gain an intuitive understanding of your business model and how it works. Think of it like a mechanic that can hear an engine running and know exactly what is right or wrong with the engine. You need to know your business. Knowing your numbers IS knowing your business.
When an employee asks for a raise, what will that do to your profitability? Will you need to adjust prices? Should you have been more proactive giving raises before you lose key staff? What happens when your supplier asks for an extra 10% due to inflation? What if lead time on equipment goes from 2-weeks to 10-weeks? Do you earn enough money to hire an administrative assistant? Can you invest $5,000 in that cool software package you want? What will you do if your sales close rate improves? What will it mean if you can drop your cost per lead by 50%?
The answers to all these questions are in your numbers. If you answer them with your gut you may be right or you may be wrong. Your gut lies to you… and tells you what you want to hear. Your numbers NEVER lie…. So KNOW YOUR NUMBERS.
I hope you learned about critical numbers you must know in your business. If you want help learning the numbers that matter in your business or just want to learn about how I coach my business owner clients to success, you can set up a discovery session by visiting my website at www.mmbizcoach.com.