March 17, 2025 • 14 mins
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Running a business is like spinning plates—but how do you know if it's truly efficient?
In this episode of Boosting Your Financial IQ, Steve reveals three key metrics every business must measure to drive growth and profitability.
Disclaimer:
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Transcript
Episode Transcript
Available transcripts are automatically generated. Complete accuracy is not guaranteed.
Speaker 1 (00:00):
If you combine this ratio together LTGP to CAC if
your ratio isn't at least threeto one, that could be a sign of
trouble as it relates to salesefficiency.
This podcast, boosting yourFinancial IQ, is about business
financial literacy, strategiesfor profitability and the
principles taught at byfiqcom.
My hope is that you'll applythe lessons learned and that we
(00:21):
can work together soon in mymastery program.
Enjoy the show and don't forgetto subscribe.
As a business owner, there areso many things to pay attention
to.
Today, I'm going to give youthree things that every business
should be measuring in order tounderstand their true economic
performance and where toidentify issues in the system
(00:42):
From the top level.
When I think of an entrepreneur, I think of somebody who's
spinning plates.
So they have a bunch of platesspinning in their hand.
They have payroll spinning overhere, customer satisfaction
over here, product and qualityover here, and they're trying to
spin all these plates and keepeverything in the air and from
falling.
And that could be quite a task,especially for entrepreneurs
(01:03):
and business owners who aretrying to juggle a lot of
different things and a lot ofdifferent business units.
I've been there before, so whatI like to do when I'm looking
at growing or just optimizing abusiness is.
I like to focus on threedifferent efficiencies First,
sales efficiency.
Second, operational efficiencyand then third, value creation
(01:24):
efficiency, or just valueefficiency.
I'm going to explain how Imeasure each of these three
efficiencies here in thisepisode.
So get ready, grab a piece ofpaper or get ready to take some
notes, because these threemeasures will be super critical
for your business.
Now, with each of theseefficiencies, I like to explain
things as a flywheel.
So think of each of theseefficiencies as a flywheel, like
(01:47):
a bicycle.
You know the big gear on abicycle, then you have the
little gear in the back.
The same thing is true withthese efficiencies.
They're like gears and like abicycle.
Sometimes it takes a little bitof effort to get the bike
moving.
To get that forward momentum,you start pedaling, you really
have to push down, but once youget the wheel spinning, the
pedal goes around faster andfaster and that's the flywheel.
(02:08):
That's the whole idea of aflywheel is, once you get it
going, then it spins faster andfaster and that's how you're
able to scale.
So the same thing is true withthese efficiencies, if you can
measure them from the very toplevel in these measures I'm
going to give you in just aminute.
Then you'll know exactly wherethings are breaking down in your
business Either it's salesefficiency, operational
efficiency or value creationefficiency and you'll know how
(02:31):
to fix them.
All right, so let's get intothe measures.
With sales efficiency, I like tomeasure this through LTGP to
CAC.
Ltgp stands for lifetime grossprofit.
Another common term for this isLTV, which stands for lifetime
value of a customer.
But I like LTGP better becauseit gets more specific.
(02:52):
It's basically the same thing.
I just think people out theremisunderstand what LTV is and
they will confuse lifetime valueof a customer with the revenue
of a customer.
Well, revenue is not thelifetime value.
You have to look at grossprofit, which is revenue minus
your cost of a customer.
Well, revenue is not thelifetime value.
You have to look at grossprofit, which is revenue minus
your cost of goods sold.
All right, so LTGP lifetimegross profit and then CAC is
(03:14):
your customer acquisition cost,the cost of acquiring a new
customer in your business.
So if you combine this ratiotogether LTGP to CAC and if you
have at least a three to oneratio, you're in good hands.
A lot of the high performingcompanies that I work with.
They have a ratio of 10 to oneor greater, which is really good
, because over time, ltgp thisratio compresses Because think
(03:39):
about it as you continue toscale your business, it's going
to be harder to find newcustomers.
You start cannibalizingcustomers in the marketplace and
therefore this number getssmaller, it shrinks.
So the bigger the gap, thebetter, and if your ratio isn't
at least three to one, thatcould be a sign of trouble as it
relates to sales efficiency.
(03:59):
All right, so, like I said, tofind LTGP you're gonna go to
your income statement, takerevenue minus cost of goods sold
that will give you gross profitand then divide that number by
the number of purchasingcustomers in that period and
then you'll figure out the grossprofit per customer.
Now for the lifetime of thecustomer the LT part of the
(04:19):
acronym.
You can either do what I do.
If I don't know the truelifetime of a customer, you can
just take one year.
That's the most conservativeway to look at LTGP.
Is you just say, okay, I'mgoing to look at the lifetime
gross profit as one year, thegross profit, in other words,
for a customer for a 12 monthperiod.
Right, that's most conservative.
Now for other businesses, whatyou could do is you could look
(04:41):
at your churn rate.
That's the number of customersyou lose in a given period.
And let's say your churn rateis 10%, that means every 10
years you'll lose all yourcustomers.
So you can do the reverse mathand figure out the lifetime of
your customers, all right.
So there are a lot of ways toget there.
Like I said, if you want abaseline that's super
conservative, just take one yearor some variation thereof.
(05:03):
Conservative, just take oneyear or some variation thereof,
all right.
So that's the first measure,which is LTGP.
Now let's talk about operationalefficiency.
When it comes to operationalefficiency, I like to measure
this by computing return onlabor.
So to find this number, youcould do a couple things with
your labor.
First, you could take totallabor for all your employees,
(05:24):
both cost of goods soldemployees and operating expense
employees or employees that areclassified in those two areas.
You could take the total laborcost of, in other words, of your
entire company and then dividethat by your net operating
profit after tax, and that willgive you your return on labor.
Now there's some variations.
Maybe you just want to measurethe return on your production
(05:47):
labor, so you may take yourproduction labor costs and
divide it by your NOPAT your netoperating profit after tax.
Or you may want to do someother combination with labor.
Whatever it is, that's the math.
It's just labor divided by yourprofit, and I like to use net
operating profit after tax.
Now you may be wondering okay,how do I treat net operating
(06:08):
profit after tax, especially ifyou're an LLC or you're an S
corp?
Because those entities in theUnited States are passed through
entities, meaning that thoseentities themselves don't pay
corporate income taxes.
Instead, the profits flowthrough on a K one to the owners
of the company, theshareholders, and they end up
(06:30):
paying the taxes.
But when it comes to looking atthe operating profit in a
business, I like to look at itnet of taxes.
So in order to compute that,there's a few ways, and I'll
just give you the quick anddirty way.
You can A go to your tax return, like if you're the sole
shareholder, look at your taxreturn and see what the
effective tax rate is that youpaid on your business's income.
(06:52):
That's one way.
The other way is just to usesome average number between, I'd
say, 30 and 35%.
If you want to be a little bitmore conservative go 35%, and
this will cover you for theintent and purpose of computing
net operating profit after tax.
Essentially, what you want to dois when you're looking at your
numbers in your business.
You don't want to just belooking at operating profit
(07:15):
before taxes, because you may betricking yourself.
Ultimately, somebody has to paytaxes, so you have to account
for that, all right, so that'show I like to compute net
operating profit after tax, evenfor businesses that are passed
through entities.
Oftentimes, I'll just use aneffective tax rate of 35% and
then, therefore, I'll take myoperating profit before taxes
(07:35):
and multiply it by one minus thetax rate, and then that will
give me a pretty good rule ofthumb for net operating profit
after tax.
And, like I said, I have toestimate the effective tax rate
because, think about it, somebusinesses have multiple owners
and each of those owners have adifferent tax rate, and
therefore, don't make it braindamage, just use some type of
(07:56):
number and that'll be goodenough.
All right, so that's how youmeasure operational efficiency.
Return on labor.
Now let's move on to the lastflywheel, which is value
efficiency.
This is how you're going tomeasure whether your business is
creating or destroying value,the metric that you're going to
use is return on investedcapital.
(08:18):
The calculation is NOPAT, so itgoes back to that net operating
profit after tax that we usedwith return on labor and you're
going to take that NOPAT dividedby your invested capital.
Now invested capital has twoparts.
First, it has working capital.
You can compute your workingcapital by going to your balance
(08:38):
sheet, taking your currentassets minus excess cash.
So if you're sitting on a tonof cash beyond what you need for
a normal, compute your workingcapital by going to your balance
sheet, taking your currentassets minus excess cash.
So if you're sitting on a tonof cash beyond what you need for
normal operations, you're goingto want to exclude that and
then take your current assetsless this excess cash and
subtract out your currentliabilities and make sure you
exclude any interest bearingcurrent liabilities.
(08:59):
So, for example, you may havethe current portion of long term
debt that's doing payablewithin 12 months.
Maybe that's in your currentliabilities.
Or maybe you're using a line ofcredit and you're paying
interest on it and it'srevolving.
You're going to want to excludethat from the calculation.
So working capital in summaryis your current assets less
excess cash, minus your currentliabilities, excluding interest
(09:23):
bearing liabilities.
All right, that's your workingcapital.
The other part of investedcapital is your net PP&E, which
PP&E stands for property, plantand equipment.
I say net because you want totake your gross PP&E on your
balance sheet and then subtractyour accumulated depreciation.
All right, I'm just summarizing.
(09:43):
There's some nuances in thecalculation, but I think this
will get you there if you justfollow this general formula.
So, like I said, return oninvested capital is your NOPAT
divided by your invested capital, and this will tell you what
your business is earning inregards to returns on your
invested capital.
The reason why this isimportant is because, let's say,
you do the math and your returnon invested capital is 5%.
(10:05):
Well, think about it In thestock market in the United
States over the last 50 years,the average returns is like 9%
to 10%.
So if you're only earning like5% or 6%, then you're earning
below average returns of whatyou could just earn by going and
buying Apple stock or Googlestock and avoiding all the
headache of running your ownbusiness.
(10:26):
Now I'm being dramatic here.
I'm not saying go sell yourbusiness and put all your money
in Apple or Google or whatever.
I'm just saying that you haveto ensure that the juice is
worth the squeeze, because, asyou know, as an entrepreneur or
business owner, like running abusiness is tough, right.
So you want to return oninvested capital that at least
exceeds what you can earn outthere in the market.
(10:49):
And the second part is yourreturn on invested capital has
to exceed your cost of capital,otherwise you're destroying
value.
So if you're blended cost ofdebt and equity, which is known
as your weighted average cost ofcapital I've done other
episodes on this, I have a videoon my YouTube channel where you
can check that out too but ifyour weighted average cost of
(11:11):
capital is 12% and your returnon invested capital is 10%,
you're destroying value becauseyou're taking money at a cost of
12% and you're only earning 10%, so therefore you're destroying
2% of value.
So therefore you know yourcompany is creating value when
your return on invested capitalis greater than your cost of
capital.
And the cost of capital variesfrom business to business.
(11:33):
I've seen some companies with a10% weighted average cost of
capital and other companies witha weighted average cost of
capital of 15% or greater.
So it varies by business.
The key thing is is to startmeasuring your return on
invested capital.
So there you go, the threemeasures for the three
efficiencies LTGP to CAC.
That's for sales efficiency,your return on labor, for
(11:56):
operational efficiency and yourreturn on invested capital for
your value efficiency.
And if you start measuringthese in your business, you'll
know which flywheels may bestuck and where you need to
focus in order to drive greatervalue overall in your business,
to improve your operational andfinancial performance.
All right, that's what I havefor you today A lot of nerd talk
(12:19):
, a lot of formulas.
Hopefully you found thatvaluable, and if you ever need
help with any of this, feel freeto reach out at coltivarcom.
We're happy to help yourbusiness put in place the right
type of metrics so you couldblend strategy and finance
together to create tremendousvalue.
All right, until next episode,take care of yourself.
Cheers.
If you combine this ratio together LTGP to CAC if
your ratio isn't at least threeto one, that could be a sign of
trouble as it relates to salesefficiency.
This podcast, boosting yourFinancial IQ, is about business
financial literacy, strategiesfor profitability and the
principles taught at byfiqcom.
My hope is that you'll applythe lessons learned and that we
(00:21):
can work together soon in mymastery program.
Enjoy the show and don't forgetto subscribe.
As a business owner, there areso many things to pay attention
to.
Today, I'm going to give youthree things that every business
should be measuring in order tounderstand their true economic
performance and where toidentify issues in the system
(00:42):
From the top level.
When I think of an entrepreneur, I think of somebody who's
spinning plates.
So they have a bunch of platesspinning in their hand.
They have payroll spinning overhere, customer satisfaction
over here, product and qualityover here, and they're trying to
spin all these plates and keepeverything in the air and from
falling.
And that could be quite a task,especially for entrepreneurs
(01:03):
and business owners who aretrying to juggle a lot of
different things and a lot ofdifferent business units.
I've been there before, so whatI like to do when I'm looking
at growing or just optimizing abusiness is.
I like to focus on threedifferent efficiencies First,
sales efficiency.
Second, operational efficiencyand then third, value creation
(01:24):
efficiency, or just valueefficiency.
I'm going to explain how Imeasure each of these three
efficiencies here in thisepisode.
So get ready, grab a piece ofpaper or get ready to take some
notes, because these threemeasures will be super critical
for your business.
Now, with each of theseefficiencies, I like to explain
things as a flywheel.
So think of each of theseefficiencies as a flywheel, like
(01:47):
a bicycle.
You know the big gear on abicycle, then you have the
little gear in the back.
The same thing is true withthese efficiencies.
They're like gears and like abicycle.
Sometimes it takes a little bitof effort to get the bike
moving.
To get that forward momentum,you start pedaling, you really
have to push down, but once youget the wheel spinning, the
pedal goes around faster andfaster and that's the flywheel.
(02:08):
That's the whole idea of aflywheel is, once you get it
going, then it spins faster andfaster and that's how you're
able to scale.
So the same thing is true withthese efficiencies, if you can
measure them from the very toplevel in these measures I'm
going to give you in just aminute.
Then you'll know exactly wherethings are breaking down in your
business Either it's salesefficiency, operational
efficiency or value creationefficiency and you'll know how
(02:31):
to fix them.
All right, so let's get intothe measures.
With sales efficiency, I like tomeasure this through LTGP to
CAC.
Ltgp stands for lifetime grossprofit.
Another common term for this isLTV, which stands for lifetime
value of a customer.
But I like LTGP better becauseit gets more specific.
(02:52):
It's basically the same thing.
I just think people out theremisunderstand what LTV is and
they will confuse lifetime valueof a customer with the revenue
of a customer.
Well, revenue is not thelifetime value.
You have to look at grossprofit, which is revenue minus
your cost of a customer.
Well, revenue is not thelifetime value.
You have to look at grossprofit, which is revenue minus
your cost of goods sold.
All right, so LTGP lifetimegross profit and then CAC is
(03:14):
your customer acquisition cost,the cost of acquiring a new
customer in your business.
So if you combine this ratiotogether LTGP to CAC and if you
have at least a three to oneratio, you're in good hands.
A lot of the high performingcompanies that I work with.
They have a ratio of 10 to oneor greater, which is really good
, because over time, ltgp thisratio compresses Because think
(03:39):
about it as you continue toscale your business, it's going
to be harder to find newcustomers.
You start cannibalizingcustomers in the marketplace and
therefore this number getssmaller, it shrinks.
So the bigger the gap, thebetter, and if your ratio isn't
at least three to one, thatcould be a sign of trouble as it
relates to sales efficiency.
(03:59):
All right, so, like I said, tofind LTGP you're gonna go to
your income statement, takerevenue minus cost of goods sold
that will give you gross profitand then divide that number by
the number of purchasingcustomers in that period and
then you'll figure out the grossprofit per customer.
Now for the lifetime of thecustomer the LT part of the
(04:19):
acronym.
You can either do what I do.
If I don't know the truelifetime of a customer, you can
just take one year.
That's the most conservativeway to look at LTGP.
Is you just say, okay, I'mgoing to look at the lifetime
gross profit as one year, thegross profit, in other words,
for a customer for a 12 monthperiod.
Right, that's most conservative.
Now for other businesses, whatyou could do is you could look
(04:41):
at your churn rate.
That's the number of customersyou lose in a given period.
And let's say your churn rateis 10%, that means every 10
years you'll lose all yourcustomers.
So you can do the reverse mathand figure out the lifetime of
your customers, all right.
So there are a lot of ways toget there.
Like I said, if you want abaseline that's super
conservative, just take one yearor some variation thereof.
(05:03):
Conservative, just take oneyear or some variation thereof,
all right.
So that's the first measure,which is LTGP.
Now let's talk about operationalefficiency.
When it comes to operationalefficiency, I like to measure
this by computing return onlabor.
So to find this number, youcould do a couple things with
your labor.
First, you could take totallabor for all your employees,
(05:24):
both cost of goods soldemployees and operating expense
employees or employees that areclassified in those two areas.
You could take the total laborcost of, in other words, of your
entire company and then dividethat by your net operating
profit after tax, and that willgive you your return on labor.
Now there's some variations.
Maybe you just want to measurethe return on your production
(05:47):
labor, so you may take yourproduction labor costs and
divide it by your NOPAT your netoperating profit after tax.
Or you may want to do someother combination with labor.
Whatever it is, that's the math.
It's just labor divided by yourprofit, and I like to use net
operating profit after tax.
Now you may be wondering okay,how do I treat net operating
(06:08):
profit after tax, especially ifyou're an LLC or you're an S
corp?
Because those entities in theUnited States are passed through
entities, meaning that thoseentities themselves don't pay
corporate income taxes.
Instead, the profits flowthrough on a K one to the owners
of the company, theshareholders, and they end up
(06:30):
paying the taxes.
But when it comes to looking atthe operating profit in a
business, I like to look at itnet of taxes.
So in order to compute that,there's a few ways, and I'll
just give you the quick anddirty way.
You can A go to your tax return, like if you're the sole
shareholder, look at your taxreturn and see what the
effective tax rate is that youpaid on your business's income.
(06:52):
That's one way.
The other way is just to usesome average number between, I'd
say, 30 and 35%.
If you want to be a little bitmore conservative go 35%, and
this will cover you for theintent and purpose of computing
net operating profit after tax.
Essentially, what you want to dois when you're looking at your
numbers in your business.
You don't want to just belooking at operating profit
(07:15):
before taxes, because you may betricking yourself.
Ultimately, somebody has to paytaxes, so you have to account
for that, all right, so that'show I like to compute net
operating profit after tax, evenfor businesses that are passed
through entities.
Oftentimes, I'll just use aneffective tax rate of 35% and
then, therefore, I'll take myoperating profit before taxes
(07:35):
and multiply it by one minus thetax rate, and then that will
give me a pretty good rule ofthumb for net operating profit
after tax.
And, like I said, I have toestimate the effective tax rate
because, think about it, somebusinesses have multiple owners
and each of those owners have adifferent tax rate, and
therefore, don't make it braindamage, just use some type of
(07:56):
number and that'll be goodenough.
All right, so that's how youmeasure operational efficiency.
Return on labor.
Now let's move on to the lastflywheel, which is value
efficiency.
This is how you're going tomeasure whether your business is
creating or destroying value,the metric that you're going to
use is return on investedcapital.
(08:18):
The calculation is NOPAT, so itgoes back to that net operating
profit after tax that we usedwith return on labor and you're
going to take that NOPAT dividedby your invested capital.
Now invested capital has twoparts.
First, it has working capital.
You can compute your workingcapital by going to your balance
(08:38):
sheet, taking your currentassets minus excess cash.
So if you're sitting on a tonof cash beyond what you need for
a normal, compute your workingcapital by going to your balance
sheet, taking your currentassets minus excess cash.
So if you're sitting on a tonof cash beyond what you need for
normal operations, you're goingto want to exclude that and
then take your current assetsless this excess cash and
subtract out your currentliabilities and make sure you
exclude any interest bearingcurrent liabilities.
(08:59):
So, for example, you may havethe current portion of long term
debt that's doing payablewithin 12 months.
Maybe that's in your currentliabilities.
Or maybe you're using a line ofcredit and you're paying
interest on it and it'srevolving.
You're going to want to excludethat from the calculation.
So working capital in summaryis your current assets less
excess cash, minus your currentliabilities, excluding interest
(09:23):
bearing liabilities.
All right, that's your workingcapital.
The other part of investedcapital is your net PP&E, which
PP&E stands for property, plantand equipment.
I say net because you want totake your gross PP&E on your
balance sheet and then subtractyour accumulated depreciation.
All right, I'm just summarizing.
(09:43):
There's some nuances in thecalculation, but I think this
will get you there if you justfollow this general formula.
So, like I said, return oninvested capital is your NOPAT
divided by your invested capital, and this will tell you what
your business is earning inregards to returns on your
invested capital.
The reason why this isimportant is because, let's say,
you do the math and your returnon invested capital is 5%.
(10:05):
Well, think about it In thestock market in the United
States over the last 50 years,the average returns is like 9%
to 10%.
So if you're only earning like5% or 6%, then you're earning
below average returns of whatyou could just earn by going and
buying Apple stock or Googlestock and avoiding all the
headache of running your ownbusiness.
(10:26):
Now I'm being dramatic here.
I'm not saying go sell yourbusiness and put all your money
in Apple or Google or whatever.
I'm just saying that you haveto ensure that the juice is
worth the squeeze, because, asyou know, as an entrepreneur or
business owner, like running abusiness is tough, right.
So you want to return oninvested capital that at least
exceeds what you can earn outthere in the market.
(10:49):
And the second part is yourreturn on invested capital has
to exceed your cost of capital,otherwise you're destroying
value.
So if you're blended cost ofdebt and equity, which is known
as your weighted average cost ofcapital I've done other
episodes on this, I have a videoon my YouTube channel where you
can check that out too but ifyour weighted average cost of
(11:11):
capital is 12% and your returnon invested capital is 10%,
you're destroying value becauseyou're taking money at a cost of
12% and you're only earning 10%, so therefore you're destroying
2% of value.
So therefore you know yourcompany is creating value when
your return on invested capitalis greater than your cost of
capital.
And the cost of capital variesfrom business to business.
(11:33):
I've seen some companies with a10% weighted average cost of
capital and other companies witha weighted average cost of
capital of 15% or greater.
So it varies by business.
The key thing is is to startmeasuring your return on
invested capital.
So there you go, the threemeasures for the three
efficiencies LTGP to CAC.
That's for sales efficiency,your return on labor, for
(11:56):
operational efficiency and yourreturn on invested capital for
your value efficiency.
And if you start measuringthese in your business, you'll
know which flywheels may bestuck and where you need to
focus in order to drive greatervalue overall in your business,
to improve your operational andfinancial performance.
All right, that's what I havefor you today A lot of nerd talk
(12:19):
, a lot of formulas.
Hopefully you found thatvaluable, and if you ever need
help with any of this, feel freeto reach out at coltivarcom.
We're happy to help yourbusiness put in place the right
type of metrics so you couldblend strategy and finance
together to create tremendousvalue.
All right, until next episode,take care of yourself.
Cheers.
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