Sustainable high-growth businesses must have an eye on margins

For most founders, the holy grail is to prove a business and ultimately become profitable. In the early days, this may seem straightforward. Creating a product or providing a service that customers need or use will lead to a prosperous, booming business. If you’re thinking that this equation sounds a bit too straightforward, you would be correct. My guest on the latest episode of Platform Diaries reminds us that revenue does not always equate to income, and only once we subtract the cost of doing business from our revenue do we find the bottom line.

Michelle Kvello is a Chartered Accountant (ICAEW) and also holds a Masters of Applied Finance (Kaplan). She is the Founder and Managing Director of Lantern Partners, a financial advisory solutions business that helps start-ups become scale-ups by stepping in as the CFO.

“Ultimately, when we talk about margins, really what we're talking about is do you have a sustainable business?” Michelle tells me.

While talk of positive income and profits may conjure up images of owning a mansion and driving a fancy car, Michelle gives us the sobering reminder that these metrics are incredibly important in determining whether your business will merely survive.

By carefully appraising your businesses’ margins and gaining a better understanding of where you make money (and where you lose it), Michelle believes you will be able to determine whether your business has longevity, or if there are practices and processes that need to change.

Gross margins can be determined through a fairly simple calculation. Michelle explains that for each incremental dollar of revenue, you must ask, ‘how much does it cost you to deliver that?’, and then ‘are you generating enough of those gross margins to cover all of your overheads?’.

Looking holistically at your business, you must evaluate whether the products or services you deliver bring in enough to cover the direct materials needed, labour costs, commissions, wages, freight costs, rent and other overheads, but generate an income over that amount.

According to Michelle, during the start-up phase, “a lot of the margin is a hypothesis. You know what you want to sell, you have a hypothesis around who's going to buy it, at what price, and what it's going to cost you to deliver that, but it takes a little while to get the data around it.”

As a start-up transforms into a scale-up, real data can feed back to the leaders and give greater insight into how to scale effectively.

Michelle offers that one key to success is ensuring that this data and the numbers are at your fingertips. It is crucial to have the management tools to be able to monitor scalability and growth.

“With any business, there are certain numbers that almost get embedded into your company mythology - ‘oh, this is a profitable customer, this is a profitable service stream, this is what it costs us to deliver X.’ Things change overtime - businesses evolve, macro conditions evolve - and so make sure you have rigour around actually what is the data, not just what I think is the data. You need to have those systems and processes already in place before you get to that scale-up stage.”

As pointed out by many of my previous guests on Platform Dairies, ensuring that your businesses’ architecture, platforms, and systems are sound from outset gives your start-up the foundations required for steady and efficient growth.

The impact of relying on outdated or false data can have dire effects on the finances of business.

Michelle says that one key mistake she sees often is “getting too attached to those hypothetical metrics, or those beliefs around what your numbers are that aren't being proved out in your data.”

“A lot of the time we [Lantern Partners] start working with businesses, and they will very confidently say ‘this is our most profitable customer’ or ‘we know this part of the business makes money’, and when you dig into it and say, ‘well how do you know?’ and ‘where is the data around it?’, they struggle. Then, when you actually do start gathering the data, quite often there are pieces of that story which actually aren't true anymore.”

Michelle’s cautionary anecdote serves as a great reminder to always view your business and its evolution objectively. Whilst particular data and assertions may have been true two years ago, as the business and market changes, it is important to stay aware. This can also mean taking a look at customers who were once cherished at the beginning of the journey and ensuring that their business is still valuable.

“I call it not being able to kill your darlings. I think founders can get really wedded to certain customers because they were a really great customer at the beginning, or you know your original product or service line, because that's what you founded your business on, but as you scale, those may not be the things that will take your business forward and to the next level.”

Michelle also warns of the temptation to get sucked into the appeal of vanity metrics.

“When you get to the scale-up phase, I think you have to be more focused on the metrics around your margin rather than just those top line, revenue, customer numbers, which sometimes referred to as ‘vanity metrics’… it's perfectly possible to grow yourself out of business. You could be 2X and 10X your revenue year after year, but you're actually losing money, and you’re driving your margins into the ground.”

A piece of advice she offers to founders is to ensure that when you are taking stock, you include incidental costs such as packaging, shipping, and logistics. Often, these are overlooked and can culminate in dodgy income figures.

While I was talking numbers with the expert, I wanted to know what sort of data would be appealing to investors versus someone looking to buy a business. Michelle tells me that she doesn’t believe, initially, there would be a huge difference.

“Both of those parties - whether they're investing in your business or whether they want to buy it - they want to get a return on their investment. They will both, at a basic initial level, be looking at the same kind of metrics - how do you make your money, when are you going to be profitable, what's the product mix that’s going to be optimal,” she tells me.

But once a return on investment has been proved, a person looking to invest in your company would evaluate the leadership team, financial metrics around customers, products and services, and whether there was potential for growth or scale. A person looking to acquire your business would have the added consideration of weighing up whether joining the business would create synergies.

So, whether you are at the beginning of your start-up journey, or you’re in the awkward adolescence phase– Michelle suggests that you start rigorously looking at the margins of your business and determining whether you will be sustainable into the future. If you’re feeling concerned, Michelle’s company Lantern Partners assists scale-ups without a full time CFO by advising them on strategic financial solutions and managing cash flow.