14/06/2021

What Does it Take to Grow Profitably ? – A Case Study

Article by Rashesh Joshi originally appeared on UK Professional

When we started Alexander Rosse our mission was, above all, to help fast-growing companies achieve their business goals. Over the years, as a chartered accountant I have found that some simple questions can occur very often. Simple does not always mean easy, however, and they can often seem to be the most difficult to address to our clients. In this article, I will look at one question that I am frequently asked and help highlight solutions.

What Does It Take to Grow Profitably?

When you ask most entrepreneurs what their business goals are, one of the most common answers will be something to do with growth. However, the real challenge is achieving both growth and profitability. As the saying goes “turnover is vanity, profit is sanity (But – Cash is God) “ – my emphasis added in the brackets.

Working on Your Processes

Ideally, you’d want the revenue generated by new customers to offset the cost of acquiring them. You want to have net cash-flow from growth that you can fund through your operating profit. I would always advise that, besides working on your cash -flow, you must also continue refining the processes you started in earlier stages of growth, namely, growing your people, and adding talent with new skills that can help you in scaling up.

An Example of a Company That’s Gone Through a Major Growth Phase

One clear case study comes to mind to illustrate my point.

Lets take a look at Xero (XRO.AX) as it is a listed company and its financials are publicly available. Xero make “beautiful accounting software” and is our software of choice for our scaling global small clients. Xero was founded in 2006 and as of 2021 it has a market capitalisation of c$AUD20bn (£11.1bn). This is twice as much as Sage (SGE.L), another accounting software provider whose fortunes have waned due to businesses adopting cloud accounting software. Sage company was not prepared for this rapid adoption and was caught on the hop. Here is a summary of Xero’s key performance indicators. As an accountant I am always stressing the importance of ‘keeping an eye on the numbers’ which is why I can’t stress enough why metrics are so important.

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Lets take a look at some of these indicators which are very impressive given the COVID19 pandemic. The company added an extra 0.4m subscribers resulting in revenues increasing by 18 % and EBITDA of just over $191m, % increase year on year (“YOY”). Critically, its free cash flow ie; the cash flow generated from operating activities less cash used for investing (eg; capital expenditure) but excluding any cash used for acquisitions almost doubled to $57m.

The company’s “AMRR” (ie; annualised monthly recurring revenue) continued is upward trend to almost $1bn. This is an important metric as it provides a 12 month forward view of revenue

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If we look at a more traditional metric like gross margin this also shows a healthy increase to just over 85% as the company found efficiencies through processes to serve an extra 0.5m customers whilst improving its gross margins.

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The customer acquisition cost (defined as being the sales and marketing costs / number of new customers) as a % of revenues is an important metric and as can be Xero’s CAC% reduced significantly from 2020 levels no doubt due to reduction in marketing spend in the first half of the covid19 pandemic. It appears the savings made on the sales and marketing side were diverted into product investment with this ratio rising to just under 37%

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The lifetime value is an important measure is the gross margin expected over the lifetime of a Xero subscriber. Many companies tend to overlook the LTV metric but the lifetime value of customers is essential to the growth of a company. The total LTV for Xero is a reflection of the number of subscribers and the LTV of a subscriber. Xero’s total lifetime value is just under $8bn. With the market valuation of Xero at $11bn, it is interesting to note that investors regard Xero very well.

Summary

Watching accounting metrics may seem mundane to some but it can be a crucial difference between becoming the next Xero, Tesla or Google or failing without achieving your true potential as a company or individuals.

As chartered accountants we are there to explain the importance of monitoring key financial metrics to our clients. Sometimes an expert impartial word with us over the phone or an email once in a while is enough to guide a fast-growing company towards their future success.

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