The average business owner does not like to discuss finance. Finance is like the vegetables in a child's lunch pack; they know they need vegetables to remain healthy, but most children can't just bring themselves to like them because they are "basic" and "tasteless". As business owners, we prefer to discuss value creation, sales strategy, marketing and other topics that stimulate creative thinking and appear more relatable. When we hear of finance, our minds quickly paint spreadsheets or balance sheets which can be nerve-wracking.
However, just like how vegetables are needed for children to be healthy, business owners need to know about finance to effectively manage their businesses and make better decisions across all boards. Unfortunately, some business owners prefer to outsource anything related to finance. As much as that is not wrong, there are some financial aspects of your business you need to understand to play an active role in the success of your business.
This article gives a concise and straightforward explanation of some important financial concepts that you as a business owner need to know. Of course, the insights from this article don't remove the need to seek specialist financial experts. Still, this piece is designed to make business owners more equipped to make smart financial decisions about their businesses.
Revenue and Profit Margin
Except you run a charity, everyone starts a business to make money. Therefore, it is hard to imagine a business owner that does not know the difference between profit and revenue. However, for the sake of clarity, a simple explanation differentiating both financial terms is given: revenue is the money you make from all business operations, while your profit is what you have left after deducting all your expenses from your revenue.
However, a concept that is taken for granted is the profit margin. Knowing your profit margin as a business owner is vital in measuring your growth. Your profit margin is simply the percentage of your expense compared to profit. For example, if you produced a product for $5 and sold it for $10, your profit margin is 100%. However, if the next month you created the same product with $5 but this time made a profit of $8, then your profit margin is 60% which is a 40% reduction from the last month. Therefore, business owners must always be conscious of profit margins because a drop in profit margin can indicate a decline in production efficiency.
Sufficiency
Sufficiency is the measure of how sustainable your business is. As a business owner, measuring your company's financial health must go beyond tracking only profit but also including how influential these profits are in sustaining your business. This brings us back to the initial point made in this article on why it is crucial for you as a business owner to know some fundamental concepts and principles about finance. An employee may be encouraged alone by the profits your business is making, but as a business owner, you must also be conscious of how sustainable your business is.
Continually monitoring your business's sufficiency will keep you on your toes for any significant capital outlay or expenditure. You don't have to make huge profits to remain sufficient; you have to understand how much you need to keep making and spending money to keep running smoothly. The 'Target Monthly Revenue' (TMR) is an advisable metric for tracking your business's sufficiency. Since most significant expenses like paying employees or paying for essential bills are made at the end of the month, having a revenue target each month can help calculate how much you would need to pay out each month and keep the business running.
Pricing Power
The price of your product or service is one of the most sensitive aspects of your business and is a continuous decision that you must always try as much as possible to get right. Your pricing power is the ability to raise the price of your products or services over time. The pricing power of your business depends a lot on the industry you are operating in and its market dynamics. Inflation - a rise in citizens' purchasing power and consequently the cost of producing a unit product - is a significant reason why increasing the price of a product is mostly inevitable.
However, as a business owner, you have to be careful that increasing the price of your service or product does not scare customers away. For example, suppose you operate in an industry where prices are susceptible, like groceries. In that case, you have to be very careful and sure before raising prices because customers in these industries will only welcome a price rise when they believe you have something unique to offer or if they also accept that inflation has increased. It is therefore advisable to experiment first before raising prices. You can do this by testing the market reaction in an isolated location or amongst a selected random group of people.
Customer Lifetime Value and Acquisition Cost
Customer lifetime value and acquisition cost are two related concepts of your business that you should understand, irrespective of the size or scale of your business. As a business owner, you must know the cost of acquiring a single customer, the cost of retaining them and most importantly, the long-term value of these customers.
Some customers prefer one-time services, and some like premiums depending on your business model. The one-time customers are not likely to return consistently, but customers who pay dividends are more likely to return. Remember how we talked about sufficiency and sustaining your business? Well, it also applies here because repeat customers or loyal customers are more likely to help you build a sustainable business. Hence, it is advisable to spend more money trying to acquire such customers and keep them.
You might point out that this sort of customer category may relate more to subscription-based companies like SaaS tech companies or insurance companies. However, it relates to all businesses. For example, even if you run a snack joint, you can identify customers that live around your area or commute more frequently along with your business location. These types of customers can then be made higher priorities compared to others.
Final Note: Increasing your revenue
There is hardly a better way to conclude this article than outlining how to make more money for your business this year. There are four strategies for increasing revenue:
Increase the frequency of transactions per customer (Make each customer return by ensuring you become their default service provider)
Increase the number of customers you serve.
Upsell: increase the average transaction size by adding more value layers.
Raise your prices (smartly 😊)