How to make sense of the financial metrics which rule your eCommerce business

Add To Cart podcast
Episode 5

In this episode of Add To Cart, we are joined by Jason Andrew, chartered accountant and corporate advisor. Jason is focused on helping eCommerce businesses take their numbers seriously – and keep themselves accountable. As Jason says, “accounting is about accountability”. In this episode, Jason explains which metrics are the most important for eCommerce retailers, how to measure them effectively and highlights the areas where he sees most eCommerce businesses fall over. 

🎧 LISTEN to the episode here:

The full episode transcript is available at the end of this post.

Questions answered in this episode include…

  • What is the most important financial metric for an eCommerce business? 
  • How do you work out unit pricing for your products factoring in all the eCommerce overheads? 
  • Does 3PL (3rd Party Logistics) make more financial sense than in-house fulfilment? 
  • What are the biggest mistakes he sees for businesses when discounting for Black Friday? 
  • How do you work out the financial impact of Customer Lifetime Value? 

🔥 Hot Tip

When we asked Jason what the most important metrics for eCommerce businesses are, he gave five: 

1. Gross profit margins 
2. Free cash flow 
3. Cash conversion cycle 
4. Return rates 
5. Discount percentage 

Are you on top of all of these?

🔗 Links from the episode 

About your co-host

Jason Andrew from SBO Financial

Jason is a chartered accountant and has over a decade of experience as a business and corporate advisor. He’s worked with businesses of all shapes and sizes from startups, scale-ups, corporates and government on a range of areas including M&A, financial strategy and performance improvement.

He’s a Co-founder of SBO.Financial – an accounting and operational finance business that services high-growth businesses across the world. SBO was founded to bring financial control, clarity and governance to entrepreneurs and high-growth businesses, helping them with bookkeeping, cash flow, metrics and improving profitability. 

As a numbers nerd, Jason is passionate about improving the financial literacy of entrepreneurs. He is the author of Stark Naked Numbers, regarded as the Barefoot Investor for entrepreneurs.

You can contact Jason on LinkedIn.

This episode was brought to you by…

Full episode transcript

Nathan Bush:
Hello everyone and welcome to episode five of Add to Cart. My name is Nathan Bush and I’m the founder of e-commerce consultancy 12HIGH. Welcome to 2020, I hope everyone had a fantastic break and are now ready to hit the ground with some vigor and let’s do it all again. Joining me on today’s episode is Jason Andrew, from SBO Financial. Now Jason, is a chartered accountant and a business advisor, but please, please don’t switch off just there. He’s also been known as a dream killer, which is a fantastic way to introduce someone. But he’s actually one of the most entertaining, humble and intelligent people that I’ve ever come across in e-commerce.

Nathan Bush:
The way that he explains financial accounting for e-commerce businesses blows my mind, and he’s actually simplified a lot of the concepts that I originally thought were just too difficult to master and he shares a lot of it on today’s episode. Now, if you’re sitting there going, “Well, I don’t look after the books. I’m not an accountant, I don’t do the finances. Why should I listen?” I think it’s really important that everyone has some level of understanding around how e-commerce businesses work from a financial sense. Because it is so tempting in an industry like ours, to sit back and just assume everything’s going to grow because it has. If we’re honest, it has grown for a long time. But it won’t always, and it’s really important to understand where those warning signs are.

Nathan Bush:
So there’s two reasons here, and I think if you’re a designer, a developer, a data analyst or a merchie going, “Well, this isn’t relevant for me.” I think it’s hugely relevant for you because one, you need to understand the financials, if you are presenting new business ideas and making business cases. By having this understanding, it’ll make your business cases and your opinions carry so much more weight, especially to your founders or CEOs. Secondly, from a personal and a career perspective, you need to understand the businesses that you’re in, so that you can make great career decisions and keep growing yourself. Now, before we jump into today’s episode with Jason, I just want to thank our partners, Shopify Plus, who bring you this episode. And we have another fantastic playbook that they’ve written, which we’ll share with you during the episode.

Nathan Bush:
Also, if you are interested in e-commerce news, trends and insights, especially from Australia, 12HIGH have a regular newsletter called HIGHmail, where we publish something called a month in review, where we collect all the stuff that you need to know from the commerce industry and we make sense of it, so that you can apply it in your businesses. We also let you know when these podcast episodes are out and give you a little bit of background information that might not be included in the podcast. So if you want to sign up to that, go to 12HIGH 1-2-H-I-G-H.com.au/highmail, H-I-G-H-M-A-I-L. And it is free. All right, onto today’s episode. I’m joined by Jason Andrew from SBO financial. Let’s kick it off. Hello Jason, welcome to Add to Cart.

Jason Andrew:
Thank you Nath. It’s a pleasure to be here.

Nathan Bush:
Mate, we’ve been talking about this for a little while. For those who don’t know you, I’m not going to introduce you as the accountant, because we might have people just turn off straight away. Mate, can you explain exactly what you do and how you’re a little bit different to most accountants going around?

Jason Andrew:
Yeah. Well Nath, I am a proud accountant. Actually I’m a proud child of an accountant. So I guess my background, I’ve worked in business and corporate advisory, generally working with high growth businesses. And again, 2015, somewhere in the accounting business called SBO financial. Now we are accountants, but we don’t do tax returns, make that very clear. What we do instead, is we do a thing called operational finance. And what that means is basically we’re embedded with our clients to help them get on top of their numbers. So that ranges from bookkeeping to cashflow management, jumping on top of the KPIs, all that fun stuff that really keeps you in business. So fundamentally, what we say is accounting and bookkeeping or traditional accounting and bookkeeping is very backwards facing. In operational finance what we do is very much focusing on the forward looking insights and the strategies and applying that really helps you grow a business.

Nathan Bush:
Beautiful. And you work with a lot of e-commerce retailers?

Jason Andrew:
Yeah. I mean, we work with three types of business models. There’s SAS, professional services and e-comm. And e-Comm’s a really interesting space and they’re actually a fun business to work with because there’s so many different leaders that you can really pull in the business and there’s so many different nuances and complexities, which makes it interesting to work with. And just given all of the retailers that we work with, high volume, high sales, you can start to tweak little things in the business and really get dramatic results to the bottom line. So they’re really fun to work with, yeah.

Nathan Bush:
Awesome. Now I’m going to plug your book because you didn’t. And I gave you the opportunity but you didn’t plug your book. Like I said, I’m 50% of the way through it and it’s such an awesome read. So it’s Stark Naked Numbers.

Jason Andrew:
Yes, that’s it. Yeah.

Nathan Bush:
Beautiful. And available on Amazon and it’s so funny, the amount of people that I’ve been speaking to recently and they’re like, “Have you read Jason’s book? It’s amazing.” So that’s the plug and the only reason we’re plugging is because we might refer to it throughout the podcast. But a really great read, for those looking to get more of Jason’s knowledge that you’ll share today.

Jason Andrew:
Pumped.

Nathan Bush:
So… Pumped. Let’s start with the numbers. So when you are working with those e-commerce businesses, what are the most important financial metrics? If you just went, “Great, I’ll open up the books,” where do you start to know if an e-commerce business is healthy?

Jason Andrew:
Yeah, so if you look at most founders of e-commerce businesses, the first things that they’ll tell you that they look at, and this is my experience empirically and probably most people is they’ll look at their Shopify account, to look at how much sales that they’ve got and then they’ll look at their bank balance, right? So, how much cash I’ve got, how much was sales. And so generally they are the two things they look at. From when I look at a set of accounts or the zero file, I look at the accounts similar to a digital market would look at a Google analytics, right? So what I look at specifically are five metrics, so I’ll look at gross profit margins, free cashflow, the cash conversion cycle, return rates and discounts. So these are five specific metrics that I really hone in on, if I want to get a good vibe of the financial health of the company.

Nathan Bush:
Okay. And you talk a lot… We might dive into a couple of those. Let’s start with gross profit, because there’s a number of ways of measuring profit, right? And you talk a lot about this in your book. Why have you picked gross profit?

Jason Andrew:
So gross profit, in my view, is the most important metric of every business. I think when people think about the size of companies, they always look at revenue, right? So everyone only talks about growing and scaling revenue and taking over the world. And you look at the media, everyone’s talking about, “Oh we made a million dollars of sales this month and we’re scaling and scaling.” But no one really talks about gross profit margins, which actually are more reflective of the financial health of the business. And I’ll explain why. So you think about everyone thinks a dollar is a dollar, right? Like $1 is the same as another. The truth is that all revenue dollars are not created equal, because your margins might differ depending on what sell.

Jason Andrew:
So when I look at a company, most founders I work with think that their gross profit is just the margin they make on their products, right? So if I sell widgets at $10, I sell it to the market for 20, that’s a 50% gross profit margin. And you’re like, “Oh yeah, cool. I’m making money.” Right? But then they forget to consider all of the fulfillment costs, the warehousing costs, the merchant fees that are paid. And so all of those costs, which are typically absorbed by the merchant, start to erode into that GP margin. So from 50%, that can drop to 20% and a 20% gross profit margin business is fairly low, it’s not really healthy. And if you just look at some simple breakeven analysis and just kind of taking a step back to understand what a healthy business look like. It looks like you need to sell a lot to make a profit on 20% gross profit. So I find that’s a really, the most important metric and probably not really appreciated by a lot of founders I work with.

Nathan Bush:
What does a good gross profit margin look like for e-commerce?

Jason Andrew:
Yeah, for e-comm businesses, generally anywhere between like 40… 40 plus percent is pretty good. And keeping in mind that’s net of all of the cost of sales, the true cost of sales, so that’s the merchant fees, logistics, as I mentioned earlier. So 40% plus is very healthy, I’ve seen businesses kind of dip into the kind of the low 30s. And that’s fine because people, if your product is a commodity product for example, you can’t really charge a premium price for that, which is why I love d-to-c brands, where they can charge whatever the market will bear and it’s good. You’re in the supply chain, so you’re skipping the middle man, you can go straight to customer and wear that margin. But yeah, for some products you just can’t charge a high margin, depending on what you sell. Yeah, so generally kind of 35 to 40% is acceptable. Anything below that, you really want to start to think, “Well, why are we doing this or are there other ways that we can increase that margin.”

Nathan Bush:
So it’s a common argument you come up against there, is to say “That’s nice in a Nirvana world, but we’re actually a volume business.” How do you come up against those kind of arguments?

Jason Andrew:
Yeah. And there is nothing wrong with the volume business. I think you just need to really take a step back and really appreciate how much volume you need to really achieve to make it worthwhile. I mean, the thing I love about economics, is that there are certain laws in the finance world, which just a true, right? And if you’re selling a 50 year old product for $40, you’re not going to make up your profits by volume. You’re just not, right? Because it just doesn’t work like that. So I think by doing a simple break even analysis, but really understanding what true numbers you need to be generating to make it worthwhile.

Jason Andrew:
That’s usually a sobering, very simple tool but very sobering experience for all the founders I work with. Because then again, a lot of the people have really grand ambitions to take over the world and scale. But you take a step back and think, “Oh wow.” To think of the customer acquisition costs to get that market share, think of all the work you need to get there. And then people go down the rabbit hole of funding and VCs and stuff, which is a dangerous one, I think.

Nathan Bush:
Yep. And is that breakeven analysis something that has to be pretty complicated or is it the kind of thing you can do on the back of a napkin just to see if an idea’s viable?

Jason Andrew:
Yeah, back of the napkin break even analysis is usually the first thing I start with when I work with people. Because I found a lot of first time founders don’t even do that, which is frightening to me because as an accountant it’s the first thing I would do, right?

Nathan Bush:
Mate, we’re retailers, just get in and do it. Just do it.

Jason Andrew:
Make it happen, right? Yeah. I mean your first off is like, well first… It comes in the planning process, where I work out, well how much can I charge for this product? How much it’s going to cost me? And then you quickly work out what’s called a contribution margin. Sorry. So that’s basically, it’s very similar to gross profit, so we’ll call it gross profit for now. And what you do is you work that percentage out and then divide that percentage by your fixed costs. So fix costs like your rent, your wages and all that sort of stuff. So that will tell you a dollar value of sales that you need, in dollars, just to break even on the fixed costs that you’ve got.

Jason Andrew:
And then you can break that sales dollar by the average sales price and then get to a unit. So then that unit price… Sorry that unit number of sales will then tell you how many you need to sell just to cover your cost basically. I’ve run that process for a lot of clients recently, particularly after Black Friday, to really workout, “Well, was it worth it, if we continue this kind of discounting regime? What volumes do we really need to make up and sell just to make it worthwhile.” Yeah.

Nathan Bush:
Yeah. Great. And I think that’s a really great tip for those who are thinking about starting a business, but also that are currently in business, to go back and do that break even analysis, really simply just to see where you sit. You’ve given some great kind of benchmarks there on what that GP should look like. When you open up the books and you look at the figures, what are the areas that often ring the loudest alarm bells for you straight away? Is there some part of those financial figures where you go, “I know if I look here I’ll be able to tell healthy or not.”

Jason Andrew:
It’s a really great question that you’ve raised because generally when I look at a set of files, I need to do a lot of work to clean up the data, just to get into a position where I can do some basic analysis. So what I mean by that is, most business owners work with an accountant or bookkeeper who are very much focused on tax compliance. So what they’re focus on is, your sales, your net profit and what’s the net profit required to do your tax return, right? They would calculate your tax. And so there’s not a lot of thought or detail made in terms of how you structure the stuff in between, like make sure you’re structuring your chart of accounts correctly, to make sure that your expenses are correctly going to cost of sales, making sure your overhead expenses are correctly allocated.

Jason Andrew:
So a lot of the time… And so when I look at a set of accounts, generally, a really poorly structured data file or just wrong incorrect information, is really telling of the financial habits in the company. So if it’s crap data, garbage in, garbage out, same analogy, generally, that’s the first warning sign. If your books are a mess, our hands on heart and say that they’ve got… Whoever’s running the business is flying blind, right? They have no idea what’s going on and again, they resort to the cash bank metric, right? It like, “If I got cash in the bank, that means that I’m good.” The risk with that is, obviously the money in your bank account isn’t always your money, right? That’s wages, that’s super, that’s owed to your employees, that’s the ATO money. So cash at bank is a really bad way to run your company. Look at your zero file, look at your financials.

Nathan Bush:
And I’ve learned, running my own businesses, is that don’t ever tell your partner or your family how much cash is in the bank because they think you’ve got a much bigger business than what you’ve really got.

Jason Andrew:
Exactly. And that’s that reality distortion field, where you see that bank balance and you know, you know right? But for most people who probably don’t have a strong grasp of financial literacy or they maybe just don’t appreciate it, they just think, “Oh, there’s a bunch of money in the bank account.” And what do you feel? You feel cashed up, right? You feel really rich because you’re like, “Woo, money to spend.” And then they spend it and then these people buy Range Rovers and buy a boat because their business is crushing it. And then suddenly you’re your September BAS is due and you realize, “Oh crap. I have to pay that somehow.”

Nathan Bush:
Yep. Yep. I think there’s a lot of hard luck stories around that and I’ve heard a lot of them recently. Let’s talk more about the e-commerce model and some of those factors or some of those costs that lead to e-commerce retailers hitting their margins. We’ve really come into a clip model for e-commerce, especially in the last five years. You’ve got a lot of people taking clips straight away, based on sales. So you’ve got your e-commerce platforms, a lot of them are taking clips now, where before it was more of a license model, which you could plan. You’ve got your payments, obviously you’re credit cards, but also you’re after pays and everyone knows how much after pay take, which is good and bad. And then you’ve started to get warehousing, especially now that you’ve got more reliance on 3PLs and they can take a bit of a clip model as well. How do you recommend setting up your product pricing with this in mind? If you were starting again do you take all those clips into account or do you just make one big assumption that the overall clip will be?

Jason Andrew:
Yeah, it’s a really great point. So I’m going to say a term, which is kind of sexy at the moment, it’s trending, but fundamentally is just accounting, unit economics, right? I’m sure you hear on the internet or everyone tries to throw around unit economics as a term. But basically what that means is, trying to work out for every widget that I sell, what are the clips? What are the true costs associated with that unit and what’s my sales price? Now everyone should do an exercise even, I would do this before I even considered starting a business, do this process where you workout, again, pretty simple, how much can I sell the product for now and where are the clips taking out of the bag and eating into my margin? So the product costs, the merchant fees you have to pay, et cetera. So then what your left is, is basically a gross profit per widget, right? And that’s really the true indicator of where your margin should fit.

Jason Andrew:
Now what most people don’t do next is they think, “Okay, the margins kind of make sense, let’s start the business.” And then 12 months later, they realize that the margin they’re actually generating is very different to what the e-commerce process was. And they’re like, “Where the hell’s the difference?” And then they realize, “Oh, I forgot about this. What about that? Oh, we discounter a bunch, so that’s where that went.” And so what I generally recommend is, you should always go back to a budget. You always have a source of truth somewhere, that you know, “Well, here are the assumptions I made in my business.” Always go to that spreadsheet or that analysis and always reference your actual state of affairs against what it should be.

Jason Andrew:
And that process itself is almost like a point of reflection to think, “Okay, is this what’s changed? What assumptions did I make that are wrong?” And then helps you decide, “Well, what do I need to tweak my business to make it worthwhile? What do I need to change?” And so accounting, in my view, is seen as this boring kind of a numbers thing but in my view, accounting is about accountability and it’s about keeping you honest to a source of truth and keeps you humble as a founder because it’s real, right? Numbers don’t lie.

Nathan Bush:
And you wonder why accountants are unpopular, when you say things like that. What retailers want to be held to account? Come on.

Jason Andrew:
You know what? I’ve been called a dream killer before. I used to be very… And part of me and my role, my persona, I guess a part of my job, is I need to be blunt, right? Because-

Nathan Bush:
Yeah.

Jason Andrew:
… the facts are the facts and this is your money, right? This is your financial health and your position and this is real stuff. And business can destroy lives if you don’t manage it properly and I’ve seen it so many times. And so, I’ve been called a dream killer and I felt that as an advisor I felt, “Oh, that’s real… I don’t want to be known as that guy.” So I went down to far the other road, where I was a bit softer. I wasn’t probably giving the hard-hitting advice I should. So I’ve kind of had to change my style, to kind of be blunt, be honest, but provide a way forward as opposed to just saying, “No, kill it. Move on”

Nathan Bush:
And I think it’s something that everyone wants to hear. One of the best quotes that I found in your book was when you said “Revenue is vanity, profit is sanity, cash is reality.” And I think just reframing things like that for people is to go, “Oh yeah, I’ve actually…” And we fall into these bad habits and you just kind of slap us around a little bit and go, “Guys, just focus on what matters here and don’t over complicate it,” which I think is really refreshing.

Jason Andrew:
Exactly. And I think business, fundamentally, isn’t that complicated. And I think people like to make business complicated. But again, fundamentally, just the best business models are the most simplest, right? They’re simple, there’s no distractions, it’s just like, we know our market, we know our products, we know our distribution channels and we just do it, right? And don’t get distracted by bright, shiny things or this new whizzbang object, whatever the marketing and software gurus are flogging nowadays. But just stay disciplined and again, look at your numbers because they keep you disciplined.

Nathan Bush:
How was your Black Friday and Cyber Monday? If you’re a Shopify merchant, I dare say it was pretty bloody good. Shopify merchants sold $2.9 billion worth of goods across 175 countries, over the Black Friday, Cyber Monday weekend. That’s a 60% increase from last year. Where Shopify excels is in those sales days, where they take care of tech to allow merchants to take care of the selling and that’s why their clients love them. If you had not such a great Black Friday, Cyber Monday, it might be worth considering whether you are on the right platform. Shopify Plus have a handy commerce evaluation guide, that walks you through what questions to ask and what you need to consider when choosing the right platform for your business. You can download the guide at shopifyplus.promo/commerceguide. That’s shopifyplus.promo/commerceguide, to get your hands on the guide today.

Nathan Bush:
When you said about being out there and putting your opinions out there, one of the things that I’ve noticed that you’ve had really strong opinions about recently is the 3PL model. And you’ve actually published a couple of articles around that and what retailers should be considering. And I think you’ve got a pretty strong view one way or the other around 3PL.

Jason Andrew:
Yeah so 3PL, it’s a big strategic question, right? So third party logistics, for those who are new to the acronym. But fundamentally, as a business owner or as a business, you can’t be an expert at everything, right? So every business has a sort of core competencies or if we talk about a brand, that, “Ah, I know where they fit in the category of the market because they excel at these certain things.” So as an example, Apple. Think about Apple, you don’t think about Apple for how good they are at building their computers or their iPad, you think about them as like they’re really customer centric. They’ve got a great design and they’re innovative, right? So there are the things that you think about as Apple.

Jason Andrew:
Now contrast that to Amazon, you don’t think about design in Amazon, you think about, “Damn, they’re really efficient. They got really good fulfillment. They’re really easy to talk to, they’re easy to deal with. So Amazon’s core competencies are very different to Apple’s. And so my point is, is every business should consider what their core competencies are in their company and what they really want to be known for and finally, let’s double down on those. And what that means is, everyone’s got limited resources. We all work with some constraints.

Jason Andrew:
So you need to pick and choose what you’re going to be really, really good at and outsource whatever you’re not going to be good at. Because there are other businesses who have core competencies of the stuff that you suck at, right? It’s just like strengths and weaknesses. So 3PL, long winded way of saying 3PL’s a really good way of outsourcing the boring back office, finicky stuff of getting your product out to customers, the picking and packing, all that stuff, which is time consuming. It’s manual and it’s just not a good use of people’s time, if your business is creating great products and getting it to your customers.

Jason Andrew:
Now when it comes to considering 3PL, we have clients that do have 3PL, we have some that just do it in-house. And there’s pros and cons and it fundamentally comes down to a numbers thing, right? So workout at what point does it make sense to partner with a 3PL provider, because they do come with a margin and they need to make money as well, they’re a business. But yeah, consider all the costs. So the freight, the warehouse rent and then think of all the labor that you’re paying. So all your staff that you’ve got in the warehouse, running around trying to pack stuff. That’s a real cost of business, if you outsource that, maybe they could be doing other things in your company, which add more value, rather than packing boxes.

Nathan Bush:
Yep. And I think it’s very easy to look at 3PL options, especially Amazon fulfillment, and look at the number on the webpage. And sometimes it can be upwards of 10% ish and that seems really expensive, right? But if you don’t do your own cost analysis on what it’s costing you to fulfill, you might be surprised by how much it’s actually costing you to fulfill.

Jason Andrew:
Exactly right. And you look at it, the biggest costs there are wages and rent. But rent, maybe you can, instead of having a warehouse, you cut 50K a month or 20 grand a month for the warehouse bill, moving to just a normal office. And suddenly you saved on your bottom line. But also the wages, again like all your staff that you employ just to pick and pack boxes, get them to do other things in your business or the sad thing, make them redundant.

Nathan Bush:
I think there are some businesses definitely who are using shipping and fulfillment as a competitive advantage, whether it’s writing personal notes, whether it’s the way that they package things up, whether it’s adding a bit of surprise and delight to that. And I think if you are doing that, you are playing in a really nice area at the moment because most people treat that moment that it goes from the warehouse into a courier’s van as just stock standard and I think it’s a nice opportunity to stand out. But if you’re not doing any of that, I think you absolutely need to look at what are the other options, if you’re just a stock standard, put it in a cardboard box and get it out.

Jason Andrew:
Yeah.

Nathan Bush:
There’s better use of your time, absolutely.

Jason Andrew:
I agree.

Nathan Bush:
We talked a little bit about Black Friday. What did you see from your clients or what are the murmurings from your clients post Black Friday, Cyber Monday, this year? Do you think firstly, was the appetite there to participate in it and secondly, how were they feeling post the event? Do you think they’ll come back again next year?

Jason Andrew:
Black Friday’s an interesting concept because… And I don’t know whether I’m just aware of it because we’re working more with e-comm retailers or it’s just the newest wave that’s hit Australia because it’s like Halloween, 10 years ago, no one was really celebrating this thing, but now it’s a thing. And Black Friday was really big, I saw a lot of ads and just walking down the mall. And there’s always shops, even just bricks and mortar shops, participating in Black Friday sales, which I found interesting, as an observation. But I also saw a lot of ads pop up on my Facebook or my Twitter with 30, 40, 50, even 60% off goods, right? And I’m thinking, “Wow, those companies are not making any money.”

Jason Andrew:
You really start to question why if you’re knocking 50% off your retail price, meant you either, you’re ripping people off with your standard product, right? If you can bare to absorb selling stuff for half price, like that’s crazy. Or you’re losing money on every sale, right? And so-

Nathan Bush:
Mm-hmm (affirmative).

Jason Andrew:
I think the biggest thing about Black Friday is not just the discounts that you’re giving to your customers and it effected your bottom line, but it’s also returns. So I think returns are really also a hidden metric that a lot of people don’t really pay attention to. So my wife’s likely, thank God she’s not a big shopper, she’s an accountant like me. She does buy stuff. But I have friends wives that buy, jump on The Iconic and buy a lot of stuff on Black Friday sales and the whole lounge room is full of boxes and packaging. And the guys are like, “Holy crap, how much money have you spent?” And they’re like, “Oh no, no don’t worry, I’m going to return most of it,” right? “Because I just want to buy it. I just want to see if I like it.”

Jason Andrew:
And so I think that the whole return culture is a really fascinating one and it’s a real cost of business. And I think if you really want to understand the efficacy of your Black Friday, of your campaign, you need to consider all the discounts of course, but then also returns, which typically don’t come into play probably one to two weeks after the sale. So Black Friday, end of November, it’s really in these two week periods post when you really start to consider all those returns to the campaign.

Nathan Bush:
Yep. And when you are considering Black Friday, how do you kind of weigh up the cost of yes, we may give away some margin here verse we may attract new customers into our business that we haven’t seen before or we wouldn’t see any other way other than giving them this great discount? Get them exposed to the brand and fingers crossed they’re going to shop with us again in the next 12-24 months at full price.

Jason Andrew:
So this is what marketers love because marketers love discounting as a customer acquisition tactic, right? It’s like, “Yeah, we’re going to discount everything to own the market and get your brand out there.” And it’s like okay, I get that. It’s a legit strategy, plenty of companies do it, but, I’ll say but, you need to do the follow on of understanding, are these people coming back? Do a true cohort analysis and follow the journey of that customer, to see if I are coming back or whether they are returning. I don’t know anyone in my network who has actually done true cohort analysis of their individual customers. Nathan, you might, you’ve seen a lot.

Nathan Bush:
Can you talk us through what a cohort analysis looks like?

Jason Andrew:
Okay, start-

Nathan Bush:
Because that might help people who aren’t doing it at all.

Jason Andrew:
Yeah, that’s a good point. So we’ll start with the principal. So the principle of discounting at Black Friday is that you’ll discount below your gross profit margin sometimes. So you’re essentially taking a hit, you’re losing money on every customer or every sale that you make. So the idea there is that, that costs is an investment because a potential new customer knows about your brand. They’ll like your product and maybe they’ll return in the future. So if you consider the customer acquisition costs, you need to consider the loss you’re making on the product or the margin, then you also consider the Facebook or the ad to get them in the first place. But then, so that forms part of your customer acquisition costs for that customer forever and then they will continue to add the more you spend on marketing.

Jason Andrew:
So what you then need to do is essentially track the behavior of that customer, to actually understand if they’re returning to buy more products from you in the future. And then selling your product to the other margin, where it starts to recruit their investment. And hopefully over the lifetime of that customer, I’ll continue to be a sticky loyal customer, where I’ll spend more money with you over the lifetime, than you spent to acquire them. Or you get to basically buy them in the first place through discounting. So that’s the concept of what lifetime value is and customer acquisition cost. So a cohort analysis is essentially just a fancy term to really understand how you can follow the customer throughout their journey and to understand if they’re making money at the end.

Nathan Bush:
Yep. Yep. No and it makes total sense. And to answer your question, I’ve never seen a business really do it really well.

Jason Andrew:
Yeah.

Nathan Bush:
We talk about it, everyone talks about it and that it’s a great thing to do. But I think at the end of a sale, what happens is everyone gets wrapped up in the excitement and to your point, is probably busy chasing returns, customer service and everything else. Everyone goes, “Oh, thank God that’s done. What’s the next step?”

Jason Andrew:
Yeah, exactly. [crosstalk 00:30:18] “Oh, you’ve got Easter coming up. Yeah. Let’s prep for that.”

Nathan Bush:
Reading your book, one of the things that I really enjoyed reading about is your calculation of customer lifetime value. And we have spoken on this podcast about it before and about, there’s really simple ways to do it. What I liked about your calculation of it is that it’s all around the profitability of the customer, not the revenue. And I know we’ve talked about this already, but can you give the equation that you use to calculate customer lifetime value based on profit?

Jason Andrew:
Yeah. So when most people think about customer lifetime value, marketers, and they’re too modest to say this, but marketers will typically look at revenue, right? They’ll calculate customer lifetime value based on your revenue. And yeah, sure, that tells me the gross value of the customer. But the problem is, as we said before, revenue is a vanity metric. You see, calculating lifetime value in revenue doesn’t actually tell you if you’re making money on that customer. So for example, if you’re buying product for 50 bucks and selling it into the market for 40, you’re losing $10 on every product. You’re CLTV or your lifetime value equation is essentially useless because you’re selling at a loss. Now what you should be doing is calculating lifetime value based on gross profit, not revenue.

Jason Andrew:
Now there’s a few ways to do it. They range for really sophisticated financey ways. But a really simple back of the envelope equation to calculate your lifetime value is simply taking your gross profit per customer, per annum and for over the year and multiplying it by the number of years that you’d expect that customer to buy from you. Now what you want to do is ensure that your customer acquisition costs are below that lifetime value, which essentially means that you’re spending money to acquire customers that are actually value equative to your business over the lifetime, as a customer to your company.

Nathan Bush:
That’s awesome. That’s really practical too. I love that. Thank you. We’re almost out of time. I could keep talking and I didn’t think I’d ever say this until I met you. I never thought I could talk about the economics of e-commerce for so long, but I really love the way you break it down. When you are looking at e-commerce businesses, what do you see as the biggest mistake e-commerce businesses are making? I know we’ve talked about GP, but where do you think most businesses go wrong? It doesn’t even have to be a specific metric, but just in their overall outlook, where do you think we’re going wrong?

Jason Andrew:
This is no one’s fault, but I think the biggest challenge is no one really knows what to look at and that’s from a business earnings perspective. So if people could take a step back and I’ll go into a bit of a personal rant about education and our literacy system. But you go to school, you go to high school, sorry, you’re not taught what a credit card is, you’re not taught what compound interest is. And then suddenly you go uni, buy a car, you get a mortgage, you have kids, and then you start a business, right? You start a business without understanding any fundamental financial knowledge. And then you’ve got wages, you’ve got super, you’ve got BAS, you’ve got payroll. And no one’s really there to tell you what you need to be doing or what you should be watching for, right?

Jason Andrew:
And again, the biggest mistake I see when I meet founders is they have no idea what they’re looking at. And that’s not their fault, they just don’t know. Who do I trust? Do I look at Shopify? Do I look at Shopify’s platform because that tells me many sales I made? Do I look at my bank balance? That’s probably the biggest source of the truth because cash is cash. Cash is king, so I can trust that. But like then this zero thing, I don’t even know what zero is, and I don’t know what the balance sheet is, that’s confusing so I’ll just look at cash. And I think that’s the biggest mistake I make, is I think people really, if you’re in business, you have a legal obligation to understand the financial position of your company and so you-

Nathan Bush:

[crosstalk 00:33:57]

.

Jason Andrew:
And legally, and if you’re a director of a company, you legally have to know the state of your company at all times forever, right? And saying that I have an accounting for that or saying I have a bookkeeper for that is not an excuse. You’re a director, you’re the one that’s liable. You need to upscale yourself, like increase the level of literacy. Now, I don’t want to plug my book, but I wrote the book to really help people lift their level of literacy, to help them grasp some fundamental principles, to just really take… At least start a journey on getting top of their numbers. Because I find that successful businesses, that you look at the best operators, they’re all numbers people, right? The CEOs of the growth companies, they think about their business as an investment, they know the numbers. And I think every business owner must know their numbers.

Nathan Bush:
Yep.

Jason Andrew:
I just went on a rant, sorry.

Nathan Bush:
It’s a brilliant rant. But I think that’s exactly right. It’s about those and you must see it all the time, those people who see you as the dream killer, are the people that don’t want to take control as well. Whereas the people who really partner with you and see their accountant as kind of the person that will enable them to grow their business, you almost become the dream maker because you can point out where they’re spending time on activities that they shouldn’t be spending time on. Can dial up the areas that are really making the money, to achieve those end goals.

Jason Andrew:
Yeah. I mean, financials is a scary topic. It’s very deep and personal and I think that, as you said, burying your head in the sand, and kind of saying that, “I’m not a numbers person,” is not an excuse. And you’re right, what we recommend to everyone listening to this if you’re in business, irrespective of you’re in the e-comm business or service business or whatever, engage more with your accountant, right? Your accountant is there… And your bookkeeper, potentially, if they got good ones. But engage with them, and really asked them for help. Ask them what these things mean. Don’t just rely on the annual kind of financial statements that they send you every year because they’re wrong. Most of the time they’re old and they’re wrong. They don’t help you make decisions, right? Engage with your accounting system, get help from your accountant and just start the journey. And I said the best business owners in the world know their numbers and I think everyone should, so start there.

Nathan Bush:
All right, that is a great point to leave it on. Thank you very much. I think you’ve been really generous with what you’ve shared. We’ve talked about gross profit and how important that is as a solid metric and how to calculate that properly. Talked about, especially for e-commerce, warehousing and returns and the impact that that can have overall on your balance sheet. Talked a little bit about Black Friday and customer lifetime value. And then overall, and I think this is the message that’s coming through is, just know your numbers. Don’t bury your head in the sand, get into it. But you don’t have to know every number, right? You just have to know the key numbers, work out what those key numbers are for you and just stay on top of it.

Jason Andrew:
Yeah, exactly.

Nathan Bush:
Brilliant. Jason, where can people find you if they want to know more?

Jason Andrew:
If you want to find me, I’m probably most active on LinkedIn, so just search me on LinkedIn, Jason Andrew. We have a blog on our company website, sbo.financial, there’s a bunch of resources there for all businesses and specifically e-comm businesses as well. And check out my book, if you’re interested to start the journey or want to lift your literacy game. You can jump on my website, it’s www.starknakednumbers.com.

Nathan Bush:
I literally downloaded it the other day and I think it was, based on memory, about $12 on Amazon.

Jason Andrew:
Yeah, it’s-

Nathan Bush:
Best $12 spent ever, awesome. Sorry if you’re going to put the price up between now and the podcast’s going live but-

Jason Andrew:
No. Well the beautiful thing about digital product, is there’s no COGs, right? So you can charge whatever you want and I won’t loose money. It’s okay. But if you buy a physical book, I need to charge you a bit more because I need to cover the cost of the printing.

Nathan Bush:
And I’m sure you’ve worked out the unit costs.

Jason Andrew:
I did.

Nathan Bush:
Yeah.

Jason Andrew:
I’d be a hypocrite if I didn’t, Nathan.

Nathan Bush:
Mate, we’re going to leave it there. Thank you so much for sharing that and I hope everyone got a couple of things that they can go back now and look at whether it’s zero, talk to their accountant, talk to their bookkeepers, just to polish up their numbers a little bit more, to make sure that what we’re doing and what we sweat over every day, all day is actually contributing to your end goal, which is, let’s make a bit of money, have a nice lifestyle and serve your customers well.

Jason Andrew:
Exactly.

Nathan Bush:
Thanks Jason.

Jason Andrew:
Thank you Nath, it was a pleasure. Thank you.

Nathan Bush:
So there you go, there’s Jason, the dream killer, Andrew spilling all things around e-commerce accounting. I found it fascinating. I know it’s not going to be everyone’s cup of tea, but if you stuck in there and you really absorbed it and you apply some of Jason’s principles, I think you will get infinite benefit for your business and for you personally in the coming years. So thank you Jason for being so generous. And like we said, if you like what Jason’s all about, grab his book. It is packed with information and a really great read for about $12, best education ever. As we said at the start, if you want more news and information around e-commerce, especially in Australia, sign up for 12HIGH email, that’s at HIGHmail. So 12high.com.au/highmail and we’ll send that out regularly. Other than that, we’ll see you back in a couple of weeks for the next episode. See you then guys, bye.