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5 Numbers Every Business Owner Should Know

Posted on March 14, 2006
Filed Under Finance & Accounting, Strategy |

What do you call a person who speaks two languages? Bi-lingual. What do you call a person who speaks three languages? Tri-lingual. What do you call a person who speaks only one language? An American. - Old Joke

Numbers are the language of business, yet many business owners don’t really know that language. They survive, but not as well as they could. My learning of this language has been completely self-taught, as a result, my understanding is less than orthodox. In some ways that’s better.

• I’ve tried to learn to use the language, not to produce reports that I’m “supposed” to have but to actually accomplish what I need. Usually what I need is some basis for making a decision. The language isn’t designed for that, but the process of learning it myself has been very helpful.
• Because I don’t know the language very well, I don’t trust my understanding of it, I usually come at a problem from several different angles. If they all point in the same direction, I’m reasonably confident that I’m on the right track. But I don’t stop looking for a new angle. This has given me confidence in my decisions through tough times.

You’ll see the ideas above in the numbers below. Advice for MBA’s and accountants: You are schooled in numbers: the language of business. But knowing the language doesn’t mean you have anything to say. If you want to help entrepreneurs, you have to learn to use that language in the context of what a small company needs.

Here are 5 numbers every business owner should know.

#1. Your COGS - Cost of Goods Sold. As a percent, this is how much of every sales dollar goes to buy the material and make it into a form that it will generate that sales dollar. If you sell only a few things, you should know your COGS for every product. If you sell a lot of items, perhaps you can group them and figure your COGS by product line or market. If you do a lot of custom work, you may need to figure out your COGS for each sale.

#2 Your Gross Profit in dollars per month. This is what’s left after you subtract COGS from your sales. This dollar amount has to cover overhead, payback and profits. It’s also the lowest price you can sell your next widget for without actually paying the customer to take it. Obviously you can’t sell them all at this price or you’d never cover overhead. But if you hit a dry spell and want to keep your crew busy, or if you want to entice a new customer with a loss leader, this is as low as you can go without really taking a loss. Gross Profit as a percentage of sales is called Gross Margin. You’ll need the margin for the next one.

#3 Value of your next customer. Here’s how it works. You take the dollar amount of your average sale TIMES the number of sales the average customer makes over their lifetime as a customer TIMES the Gross Margin. This is how much money your next customer will put in your pocket.

EXAMPLE: Let’s say you run a country club. Your average member stays a member for 5 years (60 months) and spends $1,000 a month in dues, green fees and restaurant meals. Your COGS for all that is $600 a month. So your gross margin is 40%. Your next average customer is worth $24,000: $1,000 per month sale TIMES 60 months TIMES 40%

CAVEAT: This is only true for your NEXT customer. Or the next number of customers you can serve without adding to your overhead, or making some capital expense. But in that context it can be useful to determine ways to increase the value of each customer (”You want fries with that?”) and you use it to compare to #4

#4 Cost of acquiring the next customer. This is money spent on marketing, advertising and sales DIVIDED BY the number of new customers that effort brings. Effort that brings in more value than it costs is worth it.

#5 The Magic number. Every business has one number that summarizes the health of the whole business - usually on a daily basis. Sometimes it’s obvious: a hotel uses % occupancy, a restaurant, the # of meals sold per night. But sometimes it helps to get creative. One manufacturer used the weight of all the items they shipped out in a day. It turns out for them, pounds on the shipping dock did a good aggregation of profit margins in different product lines. One restaurant owner used the number of people in line at 8:30 PM. If there were a lot of people waiting, his staff turned tables quicker to sell more meals. If not, they encouraged dessert and after dinner drinks to sell more that way.

The Magic number for a start-up is always your break even point. You must know that. When you hit it consistently you’re not a start-up anymore.

Takeaways:

• Know your numbers.
• Make them easy to use and train your staff to use them.
• Be sure you know what assumptions your numbers are based on. The Apartment industry has been using Occupancy Rates as a magic number. But recently as their market went south, staff would give away concessions (free rent) to entice people to sign leases. This kept their occupancy (and presumably bonuses), high while profits tanked. It took some companies a surprisingly long time to figure out this disconnect.

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