What are flexible metrics?
In finance, the term “soft metrics” is used to describe indicators related to a company’s value or performance that deviate from traditional “hard” metrics such as net profit margins Where earnings per share (EPS).
Soft metrics are typically used when hard metrics are difficult to obtain. During periods of irrational exuberanceas the internet bubble that happened in the late 1990s, investors often invoke soft measures to justify a company’s valuation. In these cases, company valuations would generally not be justified on the basis of concrete measures.
Key points to remember
- Soft metrics are non-traditional metrics used to assess a company’s performance.
- They are usually designed at the discretion of the company or analyst in question and therefore may be difficult to verify independently.
- Some investors will be reluctant to trust soft measures because of the ease with which they can be manipulated to produce desired results.
Understanding Soft Measures
Because they are intended to be flexible and tailored to the business in question, there is a wide variety of potential flexible measures. Indeed, given that soft metrics are not standardized and fall outside the scope of Generally Accepted Accounting Practices (GAAP)analysts are free to develop new, flexible measures as needed.
However, what most soft metrics have in common is that they seek to assess characteristics of a business that are deemed important despite not appearing directly on the financial state. For example, an Internet-based business might report its web traffic trends as a soft metric, arguing that it will be able to monetize that popularity in the future even if it doesn’t show profitability today. In this scenario, the company argues that the soft metric is an important forward-looking indicator, providing evidence that the company’s business model is fundamentally sound.
From an investor’s perspective, it’s important to treat soft metrics with a healthy dose of skepticism. After all, because they are not subject to clear and audits, companies have considerable leeway to design their soft metrics in a way that produces the desired result. This is especially true when the metric in question relies on complex calculations requiring multiple assumptions. In these scenarios, even a small change in assumptions could have a significant effect on the results. And because the company may not be required to disclose the nature of these assumptions, investors may have no way to independently verify the reasonableness of the numbers presented.
Real example of soft metrics
XYZ Corporation is an up-and-coming startup that recently completed its second fundraiser. New investors have been particularly impressed with the steady progress made in XYZ’s product development efforts, which XYZ has demonstrated through a variety of flexible measures.
Although the new fundraiser was generally considered a success, one of the venture capitalist (VC) companies that participated in the very first round of funding were conspicuously absent from the second round, opting instead to sell their position to another venture capitalist.
When asked why they chose to leave their position, the venture capital firm replied that they were not convinced by the progress claimed by XYZ on the grounds that the company had not provided them with an explanation. detail on how their soft metrics were calculated. With no concrete steps to verify XYZ’s progress, the venture capital firm did not feel comfortable continuing as the company’s backers.