What is the most important number?

Whilst the natural thing for many to focus on is revenue or bottom line profit, the one number I have always focused on which I think is the most important is gross profit. 

In the recent ZIRP years, many software companies (often encouraged by their VC investors) have layered on huge cost bases in order to chase ARR.  Most SaaS companies should be attractive with a strong gross margin of 80% + but as investors assessing new opportunities, we often find it a challenge to assess the actual gross profit of a business as it hasn’t been an area of focus.

The reason I think gross profit is the most important is revenue is often referred to as a vanity metric whereas it is gross profit not revenue that pays the Opex bills in any company.

Represented as gross margin percentage, (calculated by dividing gross profit by revenue) it serves as a benchmark for operational efficiency and I really like it when I am at board meetings and I see the team are focused on gross margins as it shows they are laser focused.   This can be achieved ijn many ways such as focusing on costs of goods, manufacturing efficiencies, service delivery and of course increases in pricing.

I attended a training course when I was in sales circa 25 years ago that has also stayed with me – it covered a negotiation case study regarding a customer buying a product with a 30% gross margin asking for a 10 discount. If you give a 10% discount (which psychologically feels modest to many sales people) this reduces the gross margin to 20%, but most importantly the business will now have to sell 50% more to that customer in order to maintain the gross profit contribution (which pays the Opex bills) to the business it had previously.

Gross profit is also the key number to consider when evaluating strategic decisions such as the profitability of new products, new markets, new development projects and the return on investment or identifying areas for cost reduction.

Renowned public and private tech investor Brad Gerstner of Altimeter Capital says that for him there are two numbers that drive valuations – growth rates and gross margins.

This is also supported by research at the McKinsey Global Institute who identified gross profit optimisation as a primary driver of shareholder value creation across multiple industries.

What number do you think is the most important?

Would be interested to hear your thoughts.