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When you measure the results of your ads, it's not enough to simply count the number of people who respond, or even the customers who buy something. What you really need to know i s the future value of each new customer.
That information can be found by figuring out a customer's marginal net worth. Despite the simplicity of calculating this figure and the benefits of knowing it, barely one in 1,000 businesses thinks in terms of a customer's actual value to their bottom line.
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Walking a Tight Rope Without a Net
Understanding your prospective customers' marginal net worth
lets you determine how much to spend to win their business. It also helps you reliably predict cash flow.
Don't underestimate the value of a careful cash flow projection. It facilitates planning decisions, allows you to prepare for downturns, and makes you aware of when to borrow.
Prospective lenders want a professionally prepared cash flow projection and knowing your customers' marginal net worth is a key part of this calculation.
Trying to succeed in business without this level of planning is like walking a tight rope without a net.
Despite the benefits of knowing the marginal net worth of customers, few businesses think in terms of a customer's actual value to the bottom line.
Take time to run the numbers, or ask your accountant to do it for you. It can put your business head and shoulders above the competition. |
There are actually two figures you need to determine: The net marketing profit and the customer's marginal net worth. It's an easy two-step calculation.
Let's say you pay $4,000 for an ad and 100 people respond. Of the respondents, 20 actually make a purchase.
Step one. Assume the 20 customers spend an average of $450 each. Subtract production and distribution costs of $240 and your gross profit on each sale is $210, or a total of $4,200 (20 times $210). Divide the cost of the ad by your 20 new customers and you see that each of them cost you $20 to acquire. Now, subtract the $4,000 ad from the $4,200 gross profit and you have net marketing profit of $200.
That may not sound like much, but look farther ahead.
Step two. Let's say that on average, each new customer makes three purchases over the next two years and the average gross profit on each sale is $300. Calculate $300 times three purchases times 20 customers and you wind up with a gross profit of $18,000. Each customer that cost you $20 to acquire, brings in $10 gross profit initially and $900 later. This is the customer's marginal net worth. This data is invaluable for these reasons:
 Smarter ad spending. You can justify spending more to win customers when you know that each will ultimately bring in $900 in gross profit. You can spend as much as $100 to bring in each new customer and still keep $800. And the higher outlay has the possibility of generating more new customers.
Better cash flow tracking. You can estimate your future cash flow with some certainty. You know that whenever you run a similar $4,000 ad, you'll probably generate about $18,000 in gross profit over the subsequent two years.
Making your business more attractive. If you want to sell your business, show a prospective buyer a projection of customers' marginal net worth. The data can go a long toward closing a sale.
So isn't it time you started thinking long-range and seeing what each of your customers brings to the bottom line?
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Our firm provides the information in this e-newsletter for general guidance only, and does not constitute the provision of legal advice, tax advice, accounting services, investment advice, or professional consulting of any kind. The information provided herein should not be used as a substitute for consultation with professional tax, accounting, legal, or other competent advisers. Before making any decision or taking any action, you should consult a professional adviser who has been provided with all pertinent facts relevant to your particular situation. Tax articles in this e-newsletter are not intended to be used, and cannot be used by any taxpayer, for the purpose of avoiding accuracy-related penalties that may be imposed on the taxpayer. The information is provided "as is," with no assurance or guarantee of completeness, accuracy, or timeliness of the information, and without warranty of any kind, express or implied, including but not limited to warranties of performance, merchantability, and fitness for a particular purpose.
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