While a new entrepreneur may not (yet) understand advanced financial and business terms and concepts, he or she understands one thing: the bottom line. Every business focuses on profit and loss.
But there are some other financial and performance measurements that can provide earlier signs of trouble — or early indications of longer-term success.
Here are six business and financial metrics no entrepreneur can afford to ignore:
1. Customer acquisition cost (CAC)
This metric measures the cost of landing a customer. In simple terms, add up the cost of marketing and sales — including salaries and overhead — and divide by the number of customers you land during a specific time frame.
Spend =N=200 and acquire 10 customers and your CAC is =N=20.
What’s a good result where acquisition costs are concerned? That depends on your industry and business model. It’s also important to understand how CAC fits into your overall operating budget. The leaner your operation is, the more you can afford to spend to acquire a customer.
Also, keep in mind that a high CAC makes sense if you also generate a high …
2. Customer lifetime value (CLV)
Unless your business is truly one-off, some percentage of customers will become repeat customers. The more repeat customers you have, and the more those customers spend, the higher CAC you can afford. (Some business models are built on breaking even on the customer’s first or second purchase; then future purchases will be profitable, since the CAC is at or near zero.)
CLV is often tricky to calculate and does involve making a few assumptions, at least during the startup phase. But once you’ve built a little history you can start to spot customer retention and spending trends.
Then the math gets a lot easier: Determine what the average customer spends over a specific time period and calculate the return on your original CAC investment. Sense-check that against your profit and loss statement. Roughly speaking, the greater the CLV, the higher CAC you can afford.
Why do these two metrics matter so much? A rising CAC means you’ll need to start cutting costs or raising prices — or do a better job in marketing and sales. A falling CLV indicates the same measures are necessary, and means you’re failing to leverage the most important and least expensive customers you have: current customers.
3. Customer retention rate
CRR is a key metric that determines whether you’re keeping customers happy — and helps you predict how quickly you can grow your business.
Customer retention rate indicates what percentage of your customers have stayed with you over a given period of time, and can be calculated on an annual, monthly, or weekly basis.
While there’s no standard formula for calculating your customer retention rate, here’s one accurate way of measuring it.
Customer retention rate = ((CE – CN) / CS) X 100
- CE = Number of customers at end of period
- CN = Number of new customers acquired during period
- CS = Number of customers at start of period
Let’s say you start the month with 1,000 customers. By the end of the month, 150 have left, but you attracted 200 new customers, so you now have 1,050 customers. Fill in the formula using those figures and it looks like this:
((1050 – 200) / 100) X 100 = 85%
So what is a good retention rate? Like many things, it depends on your industry and your goals. But the objective is to keep retention rates as high as possible.
4. Repeat purchase rate
Your repeat purchase rate is the percentage of your customers who have bought from you more than once. It shows how many have come back to buy from you after their first purchase, which provides a good indication of the success of your customer retention efforts.
You can track this metric easily by dividing the number of customers who have shopped more than once by the total number of customers.
Repeat purchase rate = Number of customers who have shopped more than once / Total number of customers
For a more detailed analysis of your repeat purchase rate, you may want to use cohorts to track it daily, weekly, and monthly. If you’re running a special promotion, cohorts can help you determine whether that specific activity led to an increase or decrease of people coming back for more.
5. Redemption rate
Creating special offers can be an effective way of bringing people back to your business — but what percentage of your offers are being redeemed?
Your redemption rate will tell you just that:
Number of offers redeemed / Number of offers issued
Your redemption rate will tell you whether your customers are taking action — usually by purchasing — when you issue an offer. If your redemption rate is low (say around 20 percent), then you’ll want to dig deeper to find out what the causes are. Perhaps your special offer isn’t enticing enough to draw people back to your business — or they’re just not interested enough in what you’re offering.
6. Revenue percentages
Very few businesses only have one source of revenue. Most have multiple sources, and changes in the contribution percentage each makes can indicate problems are ahead.
Take a fairly simple business like wedding photography. Say 80 percent of revenue historically comes from initial wedding packages sold to couples, 10 percent from additional sales after the wedding to the couple, and 10 percent from post-wedding sales to friends, family, etc.
If post-wedding sales fall off, that will impact overall profit levels, since almost all marketing and sales costs go into booking weddings — so your margins on additional sales are naturally much higher.
Changes in revenue percentages can often signal not only changes in customer spending habits but also broader trends in your industry and market.