If you hang around a group of business owners, it won’t be long until you hear something like, “Last year, my company hit fifteen million [in revenue].” Hearing those words might instantly send you into a world where you want to chase their number. Heck, if they can do it, so can you. The problem is that revenue is a vanity metric. In the personal finance world, this is the equivalent of “keeping up with the Jones.”
While revenue is important, it’s not the end all be all of business metrics. In fact, it’s easy to get into a trap chasing revenue at the risk of losing profitability.
Davis is a successful business owner. For years, his business brought in seven to eight million in revenue and was highly profitable. The company also allowed him many time freedoms. Everyone who knew him would describe him as successful. He was living the entrepreneurial dream. But one day, he told me he wanted his business to hit $10 million in revenue.
I asked, “Why $10 Million?”
He replied, “I know other people in my industry who are exceeding that number and I should be able to do it as well.”
He was puzzled when I asked, “Can your business support it?”
Chasing a revenue target just because your friends achieve that number can introduce new challenges to your business, which you might be able to support.
Can your existing team support the new target?
A few years ago, I acquired an IT training company. The company was thirteen years old and profitable, but revenues had been flat for years. To grow the business and achieve our profitability targets, we needed to add experienced staff. Experience and cheap never go together. Achieving a new revenue target meant we needed to take a hit on our profitability until the new team started producing. Since Business-to-Business IT training sales opportunities take time to close, we needed to give the team enough runway to succeed.
Because I was expecting a change in profitability, here’s what I did. First, I determined my new team’s monthly cost. Next, I estimated how long I expected it would take for the new team to achieve a profit-neutral state. This state occurs when the revenues produced by the new employees cover their costs. In my case, I expected to achieve profit neutrality in six months. Then, before I hired anyone, I took the expected monthly cost and saved it until I had six months’ pay in the bank. This approach did two things. First, it proved the business could support the new roles from existing profits. Second, because I had six months of savings in the bank, I could cover the ramp-up stage of this sales team without impacting the business’s profitability.
Davis, the business owner I mentioned above, didn’t take my approach. He instantly started hiring his new, experienced team. As you can expect, his business’s profitability began to tank. Six months after changing his goal, he told me he was losing money and needed extreme action to reduce his expenses. He went into desperate cost-cutting mode. He started terminating employees who had been with him for years. He told me, “If they don’t support revenue growth, they, sadly, have to go.”
He didn’t understand that the employees he terminated were helping to produce and support the existing revenues. After reducing his staff, the company became more profitable, but that was short-lived. Without the old team to support the existing revenues, his new team needed to spend time chasing revenue just to stay even with where they started. Now, Davis had a more expensive team chasing his old revenue targets.
But guess what? The new team could not support both the old revenue and generate new revenues, so the team expanded with new people. Davis had lost his institutional knowledge all to chase revenue.
Additional Sales require Fulfillment
Increasing sales means increasing the load on those who fulfill your orders. In the case of my IT Training business, we had excess capacity in our fulfillment areas. The operations team was not at capacity. We had excess trainer availability to support additional sales without burdening the backend team. However, if those teams were already at capacity, I would also need to plan for their expansion.
In Davis’s case, his support and fulfillment teams were able to support new volumes. But sadly, the new revenue never manifested. After two years of trying to grow revenues, Davis found that he had gone full circle. His revenues were slightly up, but his costs increased more than sales grew. His business was now less profitable.
Better Metric
Instead of chasing revenues, chase profits. As the saying goes, it’s not what you make; it’s what you keep.
Imagine how Davis’s story would differ if he had focused on his peer’s profits. He might have discovered that his peer’s businesses were less profitable. If that were true, he likely would have been content with where his business was and not desiring to grow just to chase a vanity metric.