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  3. Understand Metric Definitions

Understand Metric Definitions

  • Unit economics –  How much money you are making on each item you sell? and
  • Business Profitability – How profitabel is your overall business?

Unit Economics 

Unit Economics involves looking at the following items:

  • Revenue – the money customers pay you for products and services you sell
  • Cost of Goods Sold (CoGS) – how much it costs (in materials, etc) to make each unit you sell
  • Gross Profit – the difference between the revenue and cost of goods sold (expressed in terms of percentage of revenue, Gross Margin). The higher your gross margin, the higher the lifetime value of your customer. 

Example: So if you sell a product for $100, and it costs you $15 to make each one, you have a gross profit of $85 or a gross margin of 85%.

  • Customer Acquisition Cost – how much it costs to acquire a customer. This is the sum of the Cost of Selling (e.g. Salaries for your Sales Team, Commission for your Partners, ..)  and the Cost of Marketing (Cost of creating Leads and converting them into paying customers)
  • Net Profit – the difference between the gross profit and customer acquisition cost (expressed in terms of percentage of revenue, Net Margin)

Continuing the above example: if your cost to acquire a customer is $45, you have a net profit of $40 per unit sold or a net margin of 40%.

Business Profitability

To understand Business Profitability we have take into account

  • Operating Expenses(OpEx) – how much it costs to run your business over a period of time, typically this includes cost categories like Sales & Marketing (S&M), Research & Development (R&D), and General & Administrative (G&A). Opex can be fully tax-deducted in the same year in which the expenses occur.

  • Capital Expenditure (CapEx) are funds used by a company to acquire or upgrade long-term physical assets such as property, industrial buildings, equipment or cars. It is often used to undertake new projects or investments. These expenditures can include everything from repairing a roof to building, to purchasing a piece of equipment, or building a brand new factory. Unlike OpEx, CapEx cannot be fully tax-deducted in the same year in which the investment occurs.  
  • Depreciation is an accounting method of allocating the cost of a assets acquired with CapEx and to write-off the value of this assets over its useful life. Businesses depreciate long-term assets for both tax and accounting purposes. For tax purposes, businesses can deduct the cost of asset they purchase as business expenses; however, businesses must depreciate these assets in accordance with accounting rules about how and when the dedeuction may be taken. Depreciation is often a difficult concept for accounting students as it does not represent real cash flow. Itt is considered a non-cash transaction.

  • EBITDA (Earnings Before Interest, Taxes, Depreciation and Amortization) and EBIT (Earnings Before Interest and Taxes) are often used by investors when valuing a company. The terms can be surmised from their respective titles. Simply stated, EBIT shows a firm's operating earnings before interest and taxes but after depreciation. EBITDA calculates earnings before any depreciation or amortization is determined, i.e.
    • EBITDA is difference between the net profit across all your products sold over a period of time and the operating expenses (expressed in terms of percentage of revenue, EBITDA Margin). 
    • EBIT or Operating Income is the difference between EBITDA and depreciation / amortization across all your products sold over a period of time and the operating expenses (expressed in terms of percentage of revenue, EBIT Margin or Operating Income Margin). Obviously, the higher your EBIT, the more profitable your business operations are 

Continuing the above example:

  • if you sell 1.000 units at a net profit of 40% and your operating expenses total $25.000, then you have an EBITDA of $15.000 (= 40*1.000 - 25.000)
  • because your company has a car park, the depreciation per month totals $5.000. Then you have an EBIT of $10.000 (=$15.000 - $5000)

 

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