Growing Broke
On a radio interview, I talked about why a focus on increasing revenue can mean your business ends up growing broke.
Today I want to show how this actually happens in practice.
Growing broke is when your business gets bigger, but financially weaker.
Revenue goes up, activity increases, the team gets busier, but cash and profit go backwards.
Business 101
Many business books and even many accountants won’t tell you this, but there is a very simple rule when it comes to growing a business sustainably:
The money, time and effort you spend to acquire a customer must be less than the money you make from that customer over their lifetime.
Put another way, growth only creates value if customer lifetime value is greater than customer acquisition cost.
An example of growing broke
Let’s say you sell a product or service for $40 per month.
It costs you $35 per month to deliver that product or service.
That means you are making $5 per month from each customer.
On average, a customer stays with you for 10 months, so the lifetime value of that customer is:
$5 × 10 months = $50
Now let’s say it costs you $60 to acquire that customer.
Every time you add a new customer, you are losing $10.
Why?
Because while revenue increases by $400 ($40 × 10 months)
Your costs increase by $410 ($35 × 10 months + $60 acquisition cost)
The customer generates $50 of profit, but costs $60 to acquire.
That is growing broke.
If you add 1,000 customers, here’s what happens:
- Revenue increases by $400,000 ($40 × 10 × 1,000)
- Costs increase by $410,000 ($35 × 10 × 1,000 + $60 × 1,000)
- Profit decreases by $10,000
This is why many businesses look successful from the outside but feel constantly under pressure on the inside.
They are growing, but they are growing broke.
And that’s why revenue growth on its own is meaningless.
How do you stop growing broke?
If your accounting system is set up to give you this information, you can start making deliberate, commercial decisions to turn things around.
In this example, you could ask:
- Can we increase the revenue per customer per month?
- Can we increase how long the customer stays with us?
- Can we reduce the cost to deliver the product or service?
- Can we reduce the cost to acquire the customer?
- Or can we do several of these at the same time?
These are clear actions with measurable targets.
You are far more likely to get a positive outcome from these questions than from a generic one like:
“Why aren’t we making money?”
The real problem
Unfortunately, I see very few accounting systems set up to show:
- Customer acquisition cost
- Customer lifetime value
- Which customers actually create value
Which is why very few business owners ever ask these questions.
To solve this, I developed my Bucket Accounting System, designed to clearly separate revenue, delivery costs, acquisition costs and profit so you can see where value is really being created.
To learn more about my Bucket Accounting System, click here:
Contact Wayne on wayne@arealcfo.com.au or 0412 227 052.
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Want a confidential discussion on your business situation, help with your grant application or to learn more about my Outsourced CFO Services, simply email me at wayne@aRealCFO.com.au or call me on 0412 227 052
