When you’re building a startup, chances are you’re knee-deep in the daily grind of operating your business. From refining your product or service, to building your team, to meeting with vendors or other partners, you’re probably involved in all aspects of your business.
This leaves little time for anything else – especially the big picture perspective and thinking that’s needed to lead your business to success. Measuring that success is particularly important. It helps you determine if your company is gaining momentum and if your hard work and investments will pay off in the long run.
So how do you measure that success? It’s all about tracking key performance indicators – or KPIs. Tracking your business’ numbers, combined with regular analysis and adjustment, will empower you to make informed decisions for your business.
What KPIs should you measure?
Unfortunately, there is no easy answer.
If you’re in the hotel business, your primary KPI is likely the number of rooms booked. If you’re selling a product, sales numbers are probably the prime indicator of success. If you’re providing a service, maybe it makes most sense for you to measure sign ups or client engagements. The key is to look at your business and decide what the most meaningful indicators are for you.
One word of caution – many entrepreneurs may find it tempting to measure revenue as a sign of success. However, revenue is only one side of the equation. You also have to consider expenses and what will be left after all is said and done. A lot of companies make huge revenues, but end up with a loss at the end of year.
While KPIs will vary, there are a few indicators that are a good measurement tool for success. They are what’s called “profitability ratios.” The main profitability ratios include gross profit margin, return on assets and return on equity.
Gross profit margin
Gross profit margin shows how much of each dollar the company keeps. To calculate it, first subtract cost of goods sold from sales. Then divide by sales.
For example, let’s consider you have $500,000 in sales and the cost of goods sold is $300,000. Your profit is $500,000 minus $300,000, which is $200,000. Then, $200,000 divided by $500,000 equals a gross profit margin of 0.4 or 40 percent. In other words, for each dollar you take in, you keep about 40 cents.
Return on assets
The return on assets shows how effectively your company is using its assets in generating revenues. To calculate return on assets, divide net income by total assets.
For example, if you have a net income of $150,000 and total assets of $400,000, then $150,000 divided by $400,000 equals 0.375 or 37.5 percent.
Return on equity
The return on equity metric shows the amount of income generated using stockholders’ equity. In other words, it measures your startup’s profitability by revealing how much profit a company generates with the money shareholders have invested.
In our example, you have a net income of $150,000 and let’s assume stockholders’ equity is $200,000. Therefore, $150,000 divided by $200,000 equals 0.75 or 75 percent.
Regardless of the KPIs you settle on, you’ll want to start by setting benchmarks. This will allow you to track progress and make adjustments. If you don’t set a baseline and track the date over time, you won’t know how you’re actually doing.
It’s important to consider any variables that may affect your KPIs. As a best practice, take note of the variables that are present when you gather your baseline. Variables can include seasonality, marketing efforts, new hires, etc.
As your business grows you may also want to adjust your KPIs and begin tracking new ones.
If you’ve got questions about the KPIs we’ve outlined in this article or how to best set your KPIs, don’t hesitate to reach out to your local MidWestOne banker. We’re here for you!