A framework to optimise business profits

Newsletter #24

Writing this from the Eurostar train back to the UK.

Slightly later than usual but didn’t want to break the streak ; ).

Also really want to change the branding and name of this newsletter.

Hopefully I will get something by next week. Let’s see!

This week I want to share a framework I’ve been developing (or better put: been forcing into existence) to use with my clients.

I came to think of this after reading a very interesting book about KPIs. This book pointed out that most KPIs are not really KPIs at all, and thus have no business being tracked like one.

Usual suspects are items like “revenue” or “profits”. We think they are KPIs as they are so important. But in reality, they are only the result of what you do. You can’t just “improve” revenue. You need to know what is exactly driving this.

That’s why I’ve been thinking about breaking this down in a way that resonates with my clients. I’m finding that this approach sticks.

(I’m not saying I invented it, I just put existing concepts together in a logical way).

Framework to Optimise Profits

To optimise profits, you can’t only rely on your financial statements. These are only the scorecard of your operational efficiency.

So, to optimise your scorecard, you need to combine your operational elements with it.

To achieve that, think about three different levels:

1. Financials: standard financial information

2. Metrics: the metrics that directly impact your financials

3. KPIs: the metrics that indirectly impact your financials

What this can look like for a typical service business:

Analysing Financial statements

Your bookkeeper will probably share monthly financial statements with you.

This will tell you everything that is in the black boxes in the diagram above.

This is useful to see your revenue progress and margins:

• Revenue: how much you earned

• Gross Margin: profitability of delivering your service/product. This margin excludes your cost of sales (like freelancers hired to deliver the service or inventory to deliver the product)

• Operating Margin: profitability after running your operations. This margin excludes your cost of sales and also all operating costs (rent, marketing, salaries, travel etc.)

• Net Profit Margin: total profitability. This also excludes your tax and debt expenses and any one-off costs.

The goal of this is to monitor your performance over time and pinpoint where your (in)efficiency sits.

You want this broken down for your main product categories, divisions, or geographies. When you know your profitability per service and region you know what to put your time into.

However, this is only the result of your operations. It doesn’t tell you what exactly to improve or where your bottlenecks are. That’s where Metrics come in:

Picking your Metrics

The first step to improve your finances is to break it down into metrics.

Think about:

• Customer Acquisition Cost

• Lifetime Value

• ROAS

Improving any of these directly boosts your finances.

The key is to figure out the Metrics that are right for your business.

One approach to picking the right metrics is this:

1. Look at your Financial Statement: what are the largest revenue sources and expenses?

2. Think about the key process behind each category. What drives this process?

3. Do a simple logic test: if this “driver” would improve, would this directly translate to better performance?

4. Finally, think about whether you can easily track and calculate this information. Don’t pick things that require you to estimate or take too long to track.

Picking your KPIs

Next up, it’s time to get even more specific. Because while your Metrics have a direct impact on your finances, they are often still too “vague” to focus on. That’s where KPIs come in.

KPIs are the drivers behind the metrics you've identified.

Finding the right KPIs for your business requires a deep “bottleneck” and process analysis.

Some common KPIs for service businesses include:

• Sales calls booked

• Sales conversion rate

• Social media engagement

• Customer Satisfaction score

KPIs are personal. They depend on how you are running the business and will differ based on your lead funnels, delivery methods and personal strengths.

They should really be "leading indicators".

Example

Let's say you run a marketing agency.

You notice a drop in your operating margins.

So you check your Metrics and see your CAC going up.

Then you check your KPIs and notice your sales conversion going down.

This makes you launch a new sales training.

Data = money

Action point: analyse your financials, metrics and KPIs over time. Then dig into each specific element and see how you can improve it.

If you stay focused on this you will likely stop wasting money and you will keep focused on stability and long term value (or your numbers will reflect it!)

Best of the week

This post reminded me again of the importance of market research.

No matter what business you are in, you can’t ignore the importance of actually speaking with people.

AI can’t do that (just yet).

Hope you liked this one!

Maybe next week the newsletter will have a different name.

Or not.

Let’s see.

Until then,

Joey