I recently interviewed with a start up in Nigeria to understand what they look for in their finance employees and also to get a sense of the quality of thinking available in the space, as the Internet companies grow and become more important to the country. The start up will remain unnamed, but I was impressed with the structure and quality of their interviews. One of the questions they asked me was this: what metrics do you think it’s important for an analyst or accountant to pay attention to in a business? After the interview, I decided to expand on my answer in this post. In a nutshell, if you’re looking to understand the financial health of a company, it’s important to check out the following metrics.
- Revenue growth– if a company’s product or service is a hit, then it has to be proven by the number of people paying for it. The bigger the growth, the better, obvs.
- Net Income– again, this is intuitive. At the end of the day, are you profitable? By how much? For a company not yet profitable, the number to check is the opposite of net income, which is the cash burn rate, Knowing the size of your losses and the rate at which you’re burning cash will tell you how long you need to either become profitable or raise more capital to continue your business.
- Gross Margin– this is the ratio of gross profit to revenue. Gross profit is what’s left after you subtract the direct costs of the product or service you sold from the price you sold it at, before you subtract other costs of running your business. It’s a way to know whether you’re offering the product profitably on a unit basis and also acts as a profit cap since the net margin can never be higher than the gross margin.
- Contribution Margin– this is the additional gross profit per unit on every additional unit of product or service you sell, after you’ve incurred fixed costs and normal business costs. I won’t get technical but it’s a simple way to know for instance that, if I’m selling say, 4,000 units, how much profit does any extra unit I sell contribute to my profit or bottom line without pushing up my fixed costs. It helps you decide what maximum output you can incur and still be profitable.
- Sales efficiency– this metric measures how profitable your investment in sales are. For instance, for every $1 in sales expense I incur in a given year, if I notice a $1 increase in revenue then my efficiency is 1. If it’s higher, then that means I’m getting a lot more revenue and I should invest in more sales. If it’s less than one, it may be time to either tread cautiously, or look at other ways of boosting revenue. The inverse of this metric is the sales payback period which measures how long it takes to recover my sales spending. For instance, if my efficiency is 1 like I mentioned above, then my payback period is 12 months. Which leads us to the next metric
- Customer Churn–this metric shows how long you retain every new customer. If my sales payback period is 12 months like we mentioned above, then I want every new customer I win to stay with me for more than 12 months to make sure the cost of acquiring them is recovered. If I spend money to acquire a customer, and they leave before I can make up for that in revenue, then I’m losing money in customer acquisition. This metric is also used to calculate customer lifetime value which is a good way to know the revenue generation potential of your customer base, among other things.
- Salaries Expense– most start ups under pay their employees and make up for the difference in equity compensation. I’m not sure if Nigerian companies operate in similar ways but it’s useful to see the trend of salary compensation, whether it’s higher or lower than the market rate and how fast it is growing compared to revenue. Average revenue per employee also falls under this metric.
- Non-Personnel Marketing Spend–how is the company spending money in promotions, publicity events, sponsorship and endorsements and generally all sales activities not directly associated with the company’s employees. It’s an easy place to trim down to conserve cash or on the obverse, blow money unnecessarily.
- Cost of Capital–with each change a company makes to its capital structure, whether it is to raise more debt, or equity, or anything between, the cost of capital changes. You want to do your best to keep this as low as possible. For instance it might be better to raise equity with 10% expected return in Nigeria, than to raise commercial debt at closer to 20%. The cost of capital also acts as a good hurdle rate so that your business is investing in projects that can earn a higher return than the cost of capital if not, what’s the point?
- What’s a good tenth metric? I’d like to hear what some of you think is a good one to pay attention to. Customer loyalty/retention? Sales productivity? Employee morale? Receivables or inventory turnover ratio? Quick ratio?
It’s a plethora of things and I suspect no list is truly exhaustive as what is considered important is different for every company and industry. So look to your own circumstance to decide what to track and make sure to always stay on top of it.