The Income Statement/ Profit and Loss Statement
The income statement tells the business owner how much was made, spent, and left during a period of time. The entrepreneur has to be careful he/she does not overspend labor, cash and other resources. If the business is taking out more than it is putting in, bankruptcy is inevitable. Anticipating what is required to achieve the planned growth is essential. With careful planning, problems can be better diagnosed and the right solution can be implemented.
This article focuses on the revenue line item on the income statement. To achieve growth, pay close attention to the KPIs discussed on this page. Growth is the natural result of using the right systems with the right right product /market fit. To be the best in your chosen niche, you need metrics. You can try to wing it but your lack of a measurement system will always pull you back!
Choosing Key Metrics: Revenue
There are two (2) systems required to accurately predict revenue:
- The customer acquisition system: For a business to consistently bring people in, the market has to be big enough to have people who need your service or product. If you were a dog walker but only 10 people in the world had dogs, your market will be limited to only 10 people.
- Customer retention system: Not all customers return after their first purchase. So therefore while projecting revenue, the customer retention rate needs to be considered. To increase your customer retention rate, you will need to develop a system for engaging customers. Acquiring new customers is more expensive than retaining existing customers. Keeping existing customers happy has to be a part of your marketing strategy.
Customer Acquisition KPIs
#1) The Target Market Size
Your market size is based on how many people have the problem you are attempting to solve. For example if I make the best pizzas and will like to solve the problem of eating a quick lunch in downtown Chicago, my target market will be the number of people looking for a quick lunch in downtown Chicago.
The more defined the problem you are solving, the easier it is to define the size of your target market. It is important to note that defining your target market is not a one time event. For those who want to expand, brainstorming other markets that need your solution will be a great way to grow. But it is best to start with a very targeted market and then grow from there. The more targeted you are, the easier potential customers can find you. Having a clearly defined market, is your first task in using predictive accounting. Without knowing who your target market is you cannot move on to the next step.
#2) The Market Reach
Market reach are the number of people you can reach through your promotional efforts. Whether you are a brick and mortar business or an online business, you need a way of getting in-front of your targeted market. For a brick and mortar store, the location determines how many people will see the business in a day. For an online store, the ability to pop up in searches is one of the criteria’s used to determine traffic. There are many techniques used to drive traffic to your site or store which will not be discussed here.
Using our pizza business example, if the market size is 600,000, and you plan to reach potential customers through social media and foot traffic, your market reach will be calculated as follows:
- Number of people who walk past store during lunch = 5,000
- Number of people that can be reached through social media strategy = 100,000
- Total market reach = 105,000
The key is to go where your potential customers hang out.
#3 Response Rate
The response rate are the percentage of people who are reached by your message and respond. For example, in our pizza business example, a passerby might agree to have a taste test. This is different from the conversion rate which we discuss next. A responder simply takes an action but has not yet brought out his or her wallet. At this stage you have a prospect. A prospect is a potential customer.
#4 Conversion Rate
Congratulations! You now have traffic and people are beginning to notice and respond to your messages. But unfortunately, getting new customers is not that easy. Your next step is making them bring out their wallet. Depending on what you sell, you might need a funnel to encourage people to buy. A funnel is a series of steps your prospects go through to convince them that you are worth spending money on. In our pizza example, the conversion is very simple. Convert your foot traffic by having them try free samples or convert your social media followers to stop by with a coupon. If they like the offer, they come in the restaurant to make an order.
However, when you sell professional services, you have to convince prospects they should trust you so the process is more involved than getting people to buy a slice of pizza. You will need to get prospects into some type of marketing funnel where you can reach out to them on a regular basis with valuable resources that will enrich their life. The more you can enrich people lives, the more likely they will eventually pay you for your services.
If you have a long funnel, you have to track the conversion rate at each point of the funnel. This is the only you can figure out how to improve your conversion.
Depending on how big you want to become you need a pricing model that can scale. Sure you can charge 10,000 dollars an hour but how many customers can you realistically attract at that price point. Your price is not a function of your cost but what the market is willing to pay.
You can be successful in defining your target market, getting the traffic to your door, converting them to almost paying customers and then just as they bring out their wallet, you tell them the price. They put their wallet back in and say maybe another time. You have to understand your target market and how much they are willing to spend on a problem. Using our pizza example, the average person who eats lunch in downtown Chicago will not spend more than $10 for a personal pan. So if your personal pan is $20, you might get people to try it once but it is not a scalable price.
On the other hand, if the average Chicago pizza lover who eats downtown is used to spending $10 on a personal pan, and your cost is $2, they will walk away because they will think something is wrong with your pizza. Your probably have rat & cockroach meat disguised as sausage toppings.
There are so many factors that affect the price you charge, but the bottom line is your price depends on how much power you command in the market place. Some ways you can affect price are:
- Innovate a product people are willing to pay for but no one else produces a substitute (monopoly). Here you have the most power because if it is a product people really want, they will pay what you are asking for it.
- Or you may choose a product that only few other people produce but highly differentiate yours to drive consumers to you (oligopoly).
- Or if you choose to compete with everyone else, be sure to develop a strategy to differentiate yourself or become the cost leader.
Customer Retention KPIs
#1 Number of Existing Customers
Depending on your business, the way you define customers will vary. You can choose to define a customer as someone that patronizes your business, or someone who visited once, etc. For my purposes, a customer is someone who has done business with you at least once with whom you have enough information to contact frequently for repeat business. In other word, someone who is interested in building a relationship with your business over time.
For example, in our pizza business, 12,200 people visited the establishment last year but only 12,000 of them agreed to give contact information. 200 of the first time visitors never returned or provided contact information. I personally will not define the 200 as customers because I have no way of building a relationship. For my purposes, they were tire kickers.
The way you define customers will determine how you spend your retention marketing dollars. Do you want to spend money on tire kickers or do you want people who are willing to build a relationship with your business? I think you are better off letting the 200 go and focusing on the 12,000.
#2 Average Number of Repeat Sales Per Customer
The average number of repeat sales, is the number of times the typical customer comes to visit during the measurement period. If the typical customer visits once a month (over a year), then your average number of repeat sales is 12.
#3 Retention Rate
Retention rate is the percentage of customers you keep engaged. Using our pizza business example, of the 12,000 that chose to build a relationship, 100 of them stopped responding. For whatever reason, they decided not to patronize the business or respond to any of the offers.
When a customer has initially shown interest in patronizing and all of a sudden stops, this is worth investigating. It might be a new competitor, a bad experience, etc. Unlike the tire kicker, you do not want a once interested customer to simply die out without finding out why. If you ignore the problem, it might be the beginning of the end of your business.
To compute your customer retention rate, use the following formula:
(Number of customers at end of period – New customers acquired during the period)/Number of customers at start of period.
The Formula for Predicting Revenue with KPIs
Using the above KPIs we can predict your revenue as follows:
- Target market size * Market reach * Response rate = Prospect
- Prospect * Conversion rate (how many customers convert at the last stage of your funnel)= Acquired customers
- (Acquired customers) + (Existing customers * Retention rate) = Total customers
- Total customers * Average price * Number of repeat sales per customer = Total Revenue
The more systematized your processes are, the more reliable your predictions will be.