Imagine you’re in The Matrix.
You’re wearing a black coat.
You have a slick hairstyle and set of cool shades to go along with it.
And you’re asked to choose the blue pill or the red pill.
The blue pill guarantees to give your Ecommerce business $200,000 total revenue every year.
The red pill ensures that your business rakes in $100,000 in yearly net profit.
Which pill do you take?
If you take the blue pill ($200,000 total revenue), but you have no idea about your gross profit margin or the overhead expenses of your business, there’s a possibility that your business won’t be sustainable over the long run.
Sure, $200,000 in gross revenue sounds like a dream come true. But if your cost of goods sold and operating expenses are $210,000 per year, you’re in the red.
But if you take the red pill ($100,000 net profit) and your business raked in $50,000 net profit last year, you just doubled your net profit!
You can either reinvest your profit into your business or use a specific portion of it to use for yourself.
Either way, profitability can dictate how significant the contribution of your business is in your growth as an entrepreneur.
How can you guide your business to actually be profitable? These four cornerstone metrics are what we’re going to discuss in today’s video:
4 Cornerstone Metrics of a Profitable Ecommerce Business
1. Gross Profit Margin
Ask yourself: For every product sold, how much money is actually made?
How much did it cost you to build your product VS how much will you sell it for?
Buying from a manufacturer? Find out the cost of goods sold.
Getting it manufactured? Figure out the manufacturing costs.
You need to be highly specific about all the costs involved in producing your product. Freight fees? Packaging? Shipping charges? Add them all up.
Here’s an example to give you a clearer view.
First, get the gross profit by subtracting costs of goods sold from total revenue.
Costs of Goods Sold: $120,000
Total Revenue: $200,000
Gross Profit = Total Revenue – Costs of Goods Sold
Gross Profit = $200,000 – $120,000
Gross Profit = $80,000
Next, divide Gross Profit by Total Revenue.
Gross Profit Margin = Gross Profit/Total Revenue
Gross Profit Margin = $80,000/ $200,000
Gross Profit Margin = .40
Express it as percentages: 0.4 * 100 = 40%
Your Gross Profit Margin is 40%. And since the average in the industry is 30% – 40%, you’re in the clear.
2. Customer Acquisition Cost
Ask yourself: For every customer acquired, how much money is spent?
Let’s say your total marketing costs for June is $1,000.
And in the same month, you’ve acquired 200 customers.
Divide the total marketing costs by the number of acquired customers:
$1,000/200 = $5
For every $5 you invested in marketing, you acquired a customer.
But is this enough to measure profitability?
Don’t open the bottle of champagne just yet. We need to include the gross profit margin into the picture.
Let me paint you a picture here.
If you sold a product worth $100, good for you! But did you actually make money?
If your Gross Profit Margin is 50%, this means that yes, you “made” $50 from that product, but you also spent $50 to make that product in the first place.
“Oh…kay…”, you say. “That’s surprising, but hey, that means I made $50! Not bad…”
Sure, but we also need to factor in the customer acquisition.
In this example, it’s $50. So deducting $50 from $50 leaves you with $0 and a visceral urge to scream “Why?” into the distance.
Knowing your gross profit margin and customer acquisition cost gives you a clear reality check of whether your business will be profitable or not. Simply key in the numbers and you can objectively find out the direction your business is headed to.
3. Discounting Strategy
So now you know that for every sale, you need to deduct the gross profit margin and the customer acquisition cost, right?
Oftentimes, there’s very little money left after deducting these.
Let’s say you’re making $20 for every $100-sale. You make 20%, right?
If your discounting strategy exceeds 20%, you’re operating at a loss.
Yes, it’s viable to do this over the short-term so you can encourage more customers to purchase from you. Get them to your door with a sweet discount and then do the good old upsell.
The point here is you need to have an allowable range of discount strategy – and you need to make sure that it’s still going to give you a positive ROI, even after applying the deductibles (gross profit margin and customer acquisition cost).
4. Cash Flow
Ask yourself: How much money is actually coming in every month?
It’s possible that you “book” a profit in a month – and not receive that money yet.
An unpaid order. A manufacturing cost that’s due to be paid on that month. Or an uncleared check.
Sure, your accounting books can state that the month of June is “profitable”, but if it’s not receiving actual money, then your business will ultimately come to an end.
For a business to be profitable, you need positive cash flow.
I hope today’s video was helpful! Any other metrics you think need to be monitored for profitability? Let me know your insights below!