Whether you’re measuring KPIs, about to raise money, or planning for the future, every startup needs to keep an eye on its financial metrics. The last thing any financial manager at a startup wants is to get caught off guard when a current or potential investor raises questions about gross margins, customer acquisition costs, burn rate, or any of the many fancy terms startups tend to use when managing and planning for spend.
More importantly, it isn’t just about preventing potential embarrassment – the better the understanding of a startup’s finances, the easier it becomes to identify and rectify issues early, and ensure continued business growth.
However, with so many metrics to choose from, it can be overwhelming and confusing to single out the ones that are most relevant – after all, each startup is different, whether by way of product or priorities. The best approach is to start with a few, and to keep adding new ones as the need arises. So here’s a list of the top seven financial metrics that any startup should start tracking today.
1. Monthly run rate, AKA monthly recurring revenue (MRR)
The MRR is essentially a measure of the recurring revenue that a startup generates from its subscription customers. Particularly for SaaS-based startups, the MRR is a north star metric, as it indicator how much monthly revenue can be expected in the short term.
For example, if a company has 10,000 customers paying an average of USD 100 per month, then its MRR will be at least USD 1 million over the next several months. Similarly, investors use this rate as a means of evaluating companies by calculating how much revenue will be generated in a year. In the above example, the company can expect to make about USD 12 million in a year.
The best part about the MRR is that it factors in only predictable income, and offers a means to smarter expense management. It is a strong indicator of how well the company is doing compared to last year, and whether it can afford to meet any new expenses that come up.
The MRR is key to the outside world’s understanding of how a company is performing – whether or not it is growing, how it is growing, and how fast it is growing.
2. Cash burn rate
This is a measure of how much monthly cash a startup is burning. For example, if a startup earns USD 100 per month but then incurs total expenses of USD 120 in the same month, USD 20 is burned. This in turn indicates that in a year’s time, the company will burn around USD 240.
Another way to use this metric is to estimate how much fuel (cash) a company has before it runs out of money. In other words, it determines the length of runway a company has before it runs dry. The longer the runway, the more time a startup has to scale and grow.
3. Customer acquisition cost (CAC)
The CAC calculates all costs associated with acquiring a new customer. This may include sales, marketing and advertising, engineering, or any other costs.
CAC can make or break a startup. Though it may seem like a good idea to spend as little as possible to acquire customers, in reality, it is not that straightforward – it is a balancing act. If CAC is too high, it is only a matter of time before a startup runs out of money. If it is too low, then the business is obviously not maximizing its potential.
The trick is to find the sweet spot where the company is spending adequately to not only make money, but also to get the highest quality (and quantity of) leads.
4. CAC payback period
This is the number of months that it takes a startup to recoup its customer acquisition costs. In other words, it calculates how many months it takes a startup to “break even.” If a startup incurs USD 100 to acquire a customer that generates a revenue of USD 10 per month, the CAC payback period is 10 months.
The shorter the CAC payback period, the faster a startup can make money off a newly acquired customer.
5. Customer lifetime value (LTV)
LTV is another key metric for startups with a recurring revenue model. It indicates the average revenue expected from a customer before they churn. This factors in monthly revenue and the average time that a customer continues to subscribe to a product/service. For example, if a customer enters into a contract worth USD 100,000 for a period of five years, the LTV would be USD 500,000. Therefore, LTV can be optimized by either increasing the revenue that a customer spends, or by keeping customers happy (and paying) for longer – or both.
One of the key reasons that startups should track LTV is to analyze how much they can afford to spend on customer acquisition. For example, the CAC for a customer with an LTV of USD 500,000 can obviously be higher than that of a customer with an LTV of USD 100,000.
However, LTV need not be relevant to all startups. Performance-based startups, for example, which work on periodic budgets rather than on a fixed revenue model, may not find a lot of value in tracking LTV.
6. Gross margin
This is a crucial indicator reflecting the overall health of the company. It is calculated by subtracting the cost of goods sold (COGS) from revenue. The higher the percentage of gross margin, the better the financial health of the company.
Startups often tend to get focused on revenue, completely ignoring the money they spent to earn the same revenue. Understanding the gross margin helps paint a more realistic picture of how much revenue is actually being generated. Similar to the CAC, if the cost of producing and selling a product is higher than its returns, short- and long-term growth can be negatively impacted.
The key to increasing gross margin is to keep an eye on the ratio of revenue to COGS – improving one or both these metrics can help accelerate gross margin.
7. Cash flow
This indicates how a startup is using its cash. It includes day-to-day expenses, as well as overall operating expenses, and is another great way of determining the operational health of a company.
In a nutshell, cash flow calculates costs versus revenue, as it tracks the money going into and out of a business. A positive, free cash flow indicates high liquidity, with more money flowing into the business than going out.
Are you focusing on the right metrics?
While every startup is different and has different priorities when it comes to driving growth – whether forecast, organic growth, or performance-based – these metrics help ensure that plans stay on track, and the bottom line keeps improving. As the saying goes, you can’t improve what you can’t measure.
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