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Financial Ratios Are Sexy: Part 1

Financial Ratios Are Sexy: Part 1

Don't read this at your own peril.

Steve O'Dell
July 10, 2024

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Back to the newsletter. 🤩

Building Strength. Financial Ratios (Pt. 1)

Today’s newsletter will be the first in a series about a highly underrated concept: financial ratios. Financial ratios are probably the simplest, most practical way to evaluate the strength of your business. 💪

It's important to note that you should NOT look at other companies to set your ratios. Your job as an operator is to understand your business, not try to emulate others.

First, figure out where you are and then make your future P/L and Balance Sheet decisions to improve the numbers. In a world 🌎 where the most valuable companies are the most profitable, have the strongest balance sheets, and have efficient growth - it’s critical to build towards that, not just a “fancy P/L”.

Let’s dive into one popular ratio in Ecommerce. “Marketing Efficiency Ratio” aka MER.

In a given period, you calculate it as follows: 📱

“Total Marketing Spend / Total Revenue”

For example, if I spend $10 in a month on marketing and generate $100 in revenue, my MER is .1 ($10/$100).

Some companies, specifically in Ecommerce operate with very high MERs - say, .40 or higher. These companies have high margins, low OPEX, and plow marketing dollars back into acquisition to fuel growth. It's not a bad strategy if your cash cycles and net income % are strong.

Other, more established companies like Coca-Cola 🥤 have an MER of ~.09. Conversely, one of the greatest marketing companies of our generation, Redbull, has a MER of ~.35 (quite high!). Low-margin businesses have lower MERs, and typically forgo marketing dollars to give their clients better prices. Think manufacturers.

What if you’re well-funded and growing fast?

In the ZIRP era, operators had extremely low capital costs and plenty of venture money. They didn’t give a rat's ass about ratios, and many of them have paid the price. If your company is one of the lucky few to have raised money in the post-zirp era, I would encourage you to remain focused on the ratios. At least to know where you’re at and trending towards.

What if I’m Omni-Channel?

Omni-Channel brands must look at each channel separately. Sure, calculate all the ratios company-wide based on the P/L and Balance sheet, but you should also calculate all the P/L ratios for each specific channel each month. If you don’t do this, a lot of obvious and smart decisions will be clouded in the holistic ratios and you’ll miss out on obvious opportunities for improved efficiency.

For example, let's say you sell powdered collagen. Your gross margin on DTC (Shopify) is 80% delivered, but it is 40% in retailers. You have a .4 MER on the DTC business. If you have a .4 MER in retail, you can bet your bottom dollar that you’ll lose money. As such, you probably need to have a MER of about .1-.2 in retail to have money to cover admin and still make a profit.

🔥Make sure to calculate each channel, monthly, for the best results.

What’s the takeaway for you?

Set up a simple Google sheet and calculate all these ratios each month. Make sure every single one is trending in the right direction. Very simple, rarely done.