Question

Investors in start-ups need to know what is going on in the companies they invest in. Explain why key metrics are needed for effective and efficient monitoring by investors.

Next, for a specific business model of your choice (e.g. brick-and-mortar retail store) outline the type of information an entrepreneur should provide to the investor.

Answer 1

Your business's Key Performance Indicators (KPIs) are your tools for measuring and tracking progress in essential areas of company performance. Your KPIs provide you with a general picture of the overall health of your business. Acquiring insights afforded by your KPIs allows you to be proactive in making necessary changes in under-performing areas, preventing potentially serious losses. The KPI quantification then allows you to measure the effectiveness of your efforts. This process ensures the long-term sustainability of your company's operating model, and helps increase your business's value as an investment.

The first priority is to identify and understand the overall impact that the various financial realities represented by your KPI numbers have on your business. Then, use the insights you acquire from these invaluable financial management performance indicators to identify and implement changes that correct problems with policies, processes, personnel, or products that are impacting one or more of your KPI values.

Entrepreneurs have no trouble focusing on how to build a product, and the good ones know how to find and nurture those first critical customers. Many, however, don’t know how to take their small business to the next level. What I’m talking about here is a level of discipline and skill necessary to collect and analyze the relevant business data, known as metrics.

Here is my selection of ten key metrics that every six-sigma joint like GE tracks without thinking, but too many small businesses only monitor haphazardly, if at all:

1. Sales revenue. Sales is simply defined as income from customer purchases of goods and services, minus the cost associated with things like returned or undeliverable merchandise. Of course, everyone is happy when the numbers keep going up, but the data needs to be mined constantly for deeper meanings and trends.

2. Customer loyalty and retention. Customer loyalty is all about attracting the right customer, getting them to buy, buy often, buy in higher quantities and bring you even more customers. You build customer loyalty by treating people how they want to be treated.

3. Cost of customer acquisition. This metric is a measure of the total cost associated with acquiring a new customer, including all aspects of marketing and sales. Customer acquisition cost is calculated by dividing total acquisition expenses by total new customers over a given period.

4. Operating productivity. Obviously measuring staff productivity is important, and the reasons why are obvious. If you do not know how your staff is doing, then how can you truly know the inner workings of your own company? Staff discontent can put your company in serious jeopardy, while on the other hand, high staff productivity can be your best company asset.

5. Size of gross margin. The gross margin is calculated as a company’s total sales revenue minus its cost of goods sold, divided by the total sales revenue, expressed as a percentage. The higher the percentage, the more the company retains on each dollar of sales to service its other costs and enjoy as profits.

6. Monthly profit or loss. Profit is not simply the difference between the costs of the product or service and the price being charged for it. The calculation must include the fixed and variable costs of operation that are paid regularly each month no matter what. These include such items as rent or mortgage payments, utilities, insurance, taxes, and the salary that you and your partners are not taking just yet.

7. Overhead costs. In economics, overhead costs are fixed costs that are not dependent on the level of goods or services produced by the business, such as salaries or rents being paid per month. In any growing business, these can creep up and out of control if not tracked carefully.

8. Variable cost percentage. By definition, variable costs are expenses that change in proportion to the activity of a business. Fixed costs and variable costs make up the two components of total cost. These include the “cost of goods sold” and other items that increase with each sale, such as the cost of raw materials, labor, shipping and other expenses directly connected to producing and delivering your goods or services.

9. Inventory size. The raw materials, work-in-process goods and completely finished goods that are considered to be the portion of a business’s assets that are ready or will be ready for sale. Inventory represents one of the most important assets that most businesses possess, because the turnover of inventory represents one of the primary sources of revenue generation and subsequent earnings for the company’s shareholders/owners.

10. Hours worked per process. Beyond ratios, you need to keep metrics on total labor hours expended for various functions. Labor is likely to be your most important and most expensive raw input, especially in manufacturing, assembly, and support operations. The one constant in small business is change, so the excuse of “we have always done it that way” is not one that a growing company should ever want to hear or use.

Here is a list of the five most important things that an entrepreneur should provide to the investor and an investor wants to know before sinking money in a company.

1. Financial performance. You need to know your numbers. Prove to potential investors that your company has excellent financial performance, especially if you are seeking funding from a bank. Venture capitalists will look for a potential of high returns and a clear exit opportunity.

2. Background and experience in the industry. Investors don’t want entrepreneurs to make mistakes on their dime. Investors look for experienced entrepreneurs and management teams with a track record of high performance and leadership in the company’s industry or in prior ventures. Most investors will research your business experience and your background in the industry. Passion and commitment should be evident to inspire confidence in investors and stakeholders.

3. Company uniqueness. Your product or services need to be unique. Prove to your investors, with concrete evidence, that your market potential is big enough to make investing worthwhile.

4. Effective business model. Your company will start to display its strategic value as soon as it begins to generate profits. Present the business model that you are currently using and prove that it will help your company become more profitable.

5. Large market size. Angel investors typically invest in solutions that address major problems for significantly large target markets. On the other hand, venture capitalists look at market characteristics such as significant growth and limited competition when investing.