A key to business success is keeping a close eye on certain key performance metrics that help you monitor the health of your business.
Small business owners need to know a lot of KPI’s (Key Performance Indicators) and unfortunately, most business owners do a lousy job of reviewing the information they could easily find in financial reports from their accounting system. In most cases, they either fail to look at them regularly or simply don’t understand what the numbers mean. These numbers, however, are a very powerful and essential tool for managing any business. Without knowing how a company has performed financially, it is impossible to predict where it can go. In addition to reviewing the monthly financial statements, here are ten KPI’s that matter in all businesses, and what values constitute a healthy company.
1. Conversion Rate
Conversion rate is the number of people, figured as a percentage, who go on to take the action you want them to take. For example, it could be the percentage of website visitors who press the buy button, fill out a survey form, or show up to an invitation-only sales event. This metric helps you determine if your marketing efforts are paying off. In addition, it can provide insight into what is and isn’t working with your product, service, or messaging. To figure out your conversion rate, divide the number of completed actions (those who bought) by the number of possible completions (those who visited your site but did not buy).
2. Profits and Sales
A company can close a lot of sales but still not turn a profit. It could be that prices are set too low, or that as a business grows, its expenses grow, too, reducing profits. For example, if your company’s sales grow from $7,000 to $10,000 a month, you may automatically equate this jump in sales with $3,000 in profits. But until you run the numbers, including any increased expenses related to growth, you won’t know how much profit you earned from the increased sales. Remember, the equation to figure your profit is:
Profit = Sales – Expenses
3. Customer Referrals
When your existing customers refer you to other people, it’s a sure sign you’re doing something right. It’s important to track those referrals to measure customer satisfaction. In addition, the more referral business you get, the less you have to spend on acquiring new customers. Some businesses give referring customers a reward or incentive for every new customer they refer, while others simply thank them. You can keep track of who sends referrals your way by asking new customers how they heard about you, or by using a customer referral app like ReferralCandy.
4. Customer Lifetime Value and Customer Acquisition Cost
When you understand your customer lifetime value (CLV), you will gain a clearer picture of how important it is to retain customers, as well as how much money you should invest in acquiring more. For instance, if you run a beauty salon, and charge an average of $100 per monthly visit, and clients stay with you an average of five years, your average CLV is $6,000. To figure the CLV for your business, use the following equation:
(Average sale) x (Number of repeat transactions) x (Retention time for a typical customer) = CLV
Now that you understand what your customers are worth in dollar terms, you can determine what is reasonable to spend in advertising and marketing to attract new ones. Do this by figuring your Customer Acquisition Cost (CAC), which is how much it costs to get new business. Imagine that the beauty salon owner does a direct mailing campaign to 10,000 local residents for $2,000, and gets a 1 percent response rate. Those 100 people book an appointment, and of those, 50 percent become returning customers. To acquire the 50 new customers, it cost $40 per customer, who will spend an average of $6,000 over the next five years. When running these numbers for your business, you will have to determine what amount is reasonable in acquiring new customers for your business, based on these two metrics. To figure your CAC, use this equation:
(Marketing and advertising expenses) / (Customers) = CAC
5. Cash Flow
Without cash, your business can’t operate — so it’s important to track your cash flow on a regular basis. Positive cash flow occurs when the money coming into your business from sales and accounts receivable is more than what is going out. Negative cash flow occurs when your outgoing expenses exceed the money coming in. To keep a firm grasp on your cash flow, you’ll need to run a cash flow analysis weekly, monthly, or quarterly to make sure you have enough coming in to pay what’s coming due.
If you see that you may be entering a cash flow crunch, take some steps to try to prevent it. You can collect overdue accounts receivable, take out a loan, increase sales, and cut expenses.
Keeping an eye on your business’ financial health is critical to ensure that you are able to establish and grow a profitable company. Pay attention to the metrics described above to ensure that you give your business the best chance for success.
6. The Quick Ratio ( > 1 )
By definition, the quick ratio, or sometimes called “The Acid Test,” is found on a company’s balance sheet and is the business’ current assets (cash, cash equivalents, accounts receivables) divided by its current liabilities. A favorite metric of every bank when considering a loan, the quick ratio is a measure of the financial stability of a business. It shows that the company has more cash available than the current money it owes. In most industries, a healthy quick ratio should be greater than 1. A quick ratio can be improved through higher profitability.
7. Sales Close Ratio ( > 30%, but not too high )
It is critical to know the business’ sales process close ratio, which you get from dividing the number of sales proposals you make by the number of sales you ultimately close. Of all the prospects the company writes proposals for, how many do they win? This information should be captured and calculated in a sales customer relationship management system (CRM).
This is a key number, which should not be too low or too high. If it is too high, the company is not talking to enough prospects or its prices are too low. If it is below 30%, sales reps may not be qualifying their prospects enough before spending valuable time preparing proposals. A close ratio can be improved by using focused qualifying questions.
8. Your 10 Most Important Customers
While all customers are important, not all of them are created equal. Who are the 10 most important customers that contribute to the success of a company? This is measured not only by revenue, but by their referrals, the additional products they buy, the feedback they give and their superior brand power.
Some of this information will be captured in CRM, but other metrics will need to be collected qualitatively from the team. In many companies, these top customers contribute 70-80% of the revenue. Remember, it is typically easier to sell more to these large customers than find new ones. This is also where customer churn comes in (see number 11 below).
9. Days Sales Outstanding ( < 133% )
Days sales outstanding (DSO) is the average number of days it takes for customers to pay. The smaller the number, the better, since the business can use that cash more quickly by reinvesting it or taking it out as profit. The number should be less than 133% of the payment terms with a customer. For example, if terms are 30 days, the DSO should be 40 or less. This information on DSO can be found in the company’s accounting system. DSO can be improved by giving out less customer credit or collecting payments more quickly.
10. Operating Cash Flow ( > $1 )
How much positive operating cash flow did the business produce last month? Profit is important, but cash flow is king. This number is found in the business’ cash flow statements. By definition, cash flow is simply the sum of your monthly profit and any changes in accounts payable, accounts receivable and inventory. The higher this number is monthly, the healthier the company is. Most accounting systems will produce this statement.
Alternately, look at the company’s bank statement and subtract the ending cash balance from the beginning cash balance to see if the number is greater than 1. Cash flow can be increased by collecting customer payments faster, getting longer terms to pay bills and increasing inventory turns.
11 – Bonus! Customer Churn.
This one is particularly useful for small businesses that offer subscription based products. Customer Churn rate is the percentage of total customers who choose to stop using your service during a given period. Learn more about why customers churn.
If this is all confusing, get an accounting system that can easily report the data. Only by knowing these numbers can you know your business with confidence.
Read more on the 8 Accounting Formulas every business should know.