Knowing Your Numbers: Primer on Understanding the Economics of Your Business

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Knowing your numbers, or deeply understanding the economics of your business, is extremely important. Being a great founder doesn’t always mean that you know how healthy your business’ finances are.

In fact, many businesses fail because the founders aren’t aware of this critical information.

If you doubt that you’re seeing the full financial picture of your company, here are the main financial metrics you should be paying attention to:

The difference between users and customers

Users spend time on your platform.

Customers pay for the products on your platform.

Facebook, for instance, doesn’t charge its users. It charges advertisers.

Eyeballs, clicks, likes, etc., are nice, but revenue is what you’re shooting for, and, of course, profit.

Frequency of transactions

How often do customers pay you for your product or service?

Is it recurring (i.e., subscription-based) or is it one time?

Revenue drivers

Is your product volume-driven or price-driven?

Do you need to sell more items or do you need to charge more?

Revenue vs cash flow timing

The time that passes between the moment you generate revenue (make a sale) and the moment you collect the cash.

Many of your customers might pay on a net-30 or net-60 basis, for example.

That means you’ll need at least 30-60 days worth of savings to cover that time period.

Of course, you should have enough cash reserves on hand to weather a much longer period, if necessary should anything happen.

Managing a business fairly conservatively and not putting all your capital to work may cost you some expected revenue, but long-term sustainability depends on having a more than adequate cushion.

Your biggest costs (and how to lower them)

Is labor your biggest cost?

Then overseas workers will be cheaper and think about automation and AI tools.

For example, if you’re a content business, your biggest cost is probably freelance writers. Think about how to get good quality at the best price and think about tools that can help you in this regard (e.g., AI writing assistants).

How are you going to find new customers?

You need a way to replenish your lead pool as customers leave.

Create a system that assures constant customer acquisition.

You must also know your customer acquisition cost (CAC) and the average revenue per customer from all your marketing channels.

Churn rate

In a year, what’s the percentage of customers that stop buying from you? This is your churn rate.

Ideally, the new customers you add up every year should make up for this loss.

Fixed and variable costs

These are costs that fluctuate based on how much you sell.

Also, advertising costs belong to this category since they change over time.

Fixed costs are the ones you need to sustain no matter how much you sell.

Think about employees, software, etc.

Unit economics

What’s the margin on every unit you sell?

This is calculated by subtracting the total costs (fixed and variable costs) per unit from the revenue per unit.

Gross margin

This equals the sales minus the cost of goods sold (COGS). It doesn’t take into account the fixed costs.

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