In this episode of the Mission Business Podcast, we talk about specific metrics a business should track to gauge its overall profitability and health. While every business is unique and will have different metrics, there are foundation level metrics that apply to any business. In this episode, we share those metrics and how to use them.
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Interviewer: Welcome to the Mission Business Podcast. What we’re going to talk about with Bernard today is specific metrics that you should be tracking in your business to gauge the overall health of the business.
Why Tracking Is Important
Interviewer: Obviously every business is unique and there are going to be different numbers tracked in different businesses, but there are foundation level metrics that apply to any business. Before we get into specific metrics that you should be tracking, Bernard, can you share with us the overall importance of why a business needs to be tracking metrics?
Bernard: It’s important to track metrics because as a business owner you may be very much embroiled in the day-to-day business and you may have some preconceived notions as to what you should do to achieve a profitable situation with good cash flow.
- An example is many of my business owners chase sales. They really are obsessed with sales. Sales is good, but the sales does not necessarily translate into profits.
Interviewer: That’s definitely a good point.
“Gross Profit” and Why Is It Important
Interviewer: Let’s transition into talking about specific metrics that a business should be tracking. Can you share with us one specific metric that a business should be tracking and what next actions a business owner can actually take using that metric?
Bernard: As I‘ve said, sales is only one metric and everybody is thinking of capturing sales and how much do we sell. But in my opinion what’s more important than sales is the gross profit.
- Gross profit is really your sales minus the cost of those sales; either the cost of the goods or the cost of the services to provide a sale.
- It doesn’t really matter if you sell $1000 if your gross profit is just $1.
So, the bottom line is really what’s important for the business is to achieve a very healthy gross profit. My favorite metric is really the gross profit as a percentage of sales or gross margin. We want a business to be really taking a look at that and make sure we don’t inadvertently let this metric erode. We want to have healthy gross profit percentages.
Measuring Profitability in Different Type of Businesses
Interviewer: How would different businesses go about actually tracking that gross profit percentage? Obviously different businesses have different numbers that impact that percentage. So how do you accommodate for that?
Bernard: Essentially in my world you have two types of businesses. You have businesses that sell goods and businesses that sell services.
If you’re selling goods, you want to have a good inventory system so that;
- You can receive your inventory and
- Capture it in a piece of software like QuickBooks or Peachtree or others so that you know what the cost of the goods are.
- Then when you sell it, your profit would be the difference between the selling price and the cost of what you’re selling.
- Then you can compute the gross margin.
In case of service businesses, these would be more of project cost type. Say you have a consulting business. It would have a project cost and would require you to record the following information;
- You want to capture the sales,
- Keep a track of revenue from that project, and
- Then accumulate all the direct costs that were incurred to complete this project. It would include labor and some overheads, and maybe some reimbursable materials.
- In the end, you would want to know what the gross profit was on that particular project and there are many different ways to do that.
Once you have that, you can do a cost analysis and see how some of the products are more profitable than others.
- Are you selling some products at a lower margin than you would like to?
- The same would apply to projects; some may be more profitable than others.
Ideally you want to do more of the more profitable stuff and less of the less profitable stuff.
Comparing Overhead Expenses With Total Profits
Interviewer: So apart from gross profit, what’s another metric that you’ve seen business owners make the mistake of not tracking?
Bernard: Obviously, once you’ve focused on gross profit, you’ll want to optimize your gross profit.
- The gross profit in my view is sort of your topmost line, whereas
- You want to have money in the bottom line
What’s the difference between gross profit or the topmost line and the bottom line? – It’s really your overhead expense and the cost of running your business.
These are the costs that are not directly attributable to either;
- A particular product or
- A particular service or
- Project that you sell
With the cost of your accounting, your rent, your insurance and all these costs, you really want to have a good command as to what really it is per month. Let’s say it’s $50,000 per month. You really want to have a sense to what this figure is and what this overhead cost or general cost amounts to, as a percentage of your gross profits.
Let’s say your gross profit is $70,000 a month and you find that your overhead is $50,000. So you look at that and you say, “Well, that’s about 75% of my gross profit.” Obviously you want your general expenses to be less than your gross profit so that you can have a healthy bottom line.
Interviewer: That’s definitely helpful. Between tracking gross profit and keeping track of your overhead, it sounds like you’re going to be in good position in your business to know those foundation level numbers in the business.
More Will Follow In Coming Weeks
We’re going to be putting out more episodes and more content on the website about how to actually track these metrics and much more about running your business. Thank you so much for your time in reviewing this today, Bernard.
Bernard: You are very welcome.
We Are Happy To Help
You can contact us today to book a free consultation. We can do a comparative analysis of your business’s expenses and cash flow to work out the profitability percentage.
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