Conventional wisdom says that you can’t improve what you can’t measure. Many startup founders take this wisdom to heart, and they try to measure as many metrics as they can. Financial metrics help a startup analyze its business model to determine when to double down, when to hold, and when to fold.
The principal job of a startup is to grow and scale. Without improvement and growth, startups fail – and they do so at an alarming rate. To paraphrase Steve Blank, a startup is an organization formed to search for a repeatable and scalable business model. Financial metrics are like putting your cards face up on the table. They can show solid evidence that your startup is on the right track to repeatability and scalability. They can also help you evaluate whether your startup’s business model is sustainable. When you know your numbers, your metrics will also allow you to “fail fast” if your company seems to be holding a pair of threes instead of a Royal Flush.
With a failure rate of close to 90% despite that fact that startups generally keep a good eye on their finances – if for no other reason than money is tight and needs are great – we have to ask, “Are startups measuring the right things?
Below are the key metrics your startup needs to measure to keep it on the right track. Tracking these metrics will ultimately tell you if your startup has a sustainable business model. These few financial metrics should be measured and updated consistently so that the founders or executive team knows at all times how the business is faring and what its prospects are.
Here are the key metrics to measure:
1) The total cost of running your startup. Be sure to include both fixed and variable costs, and don’t forget less obvious costs like taxes (income and employment) and insurance.
You can’t figure out your runway until you know your costs.
2) Your startup’s break-even point. Once you know the total cost of running your startup, you can figure out what level of sales revenue you need to pay those expenses. The point at which revenues equal expenses is your break-even point. Knowing your break-even point can help you figure out how much runway you are going to need.
3) Cash flow, cash flow, cash flow. Your cash flow measures cash coming in and cash going out. Positive cash flow is the lifeblood of every business. Positive cash flow means your startup has more cash coming in that it has going out. Negative cash flow is simply the reverse. Your startup needs to track actual flows, and it also needs to forecast future cash flows.
When you forecast, you determine how much will be coming in and when, what cash is going out, and how much you will have left over (if any). By looking ahead, you will be able to identify cash flow problems and plan accordingly. Cash flow forecasting also gives you a tool to evaluate the sustainability of your business model. If your startup consistently has a negative cash flow, there may be a problem with your business model.
4) Sales and marketing efficiency. Achieving sales and marketing efficiency is one way to show that your startup has a repeatable and scalable business model. This efficiency has two main components: (1) Customer Acquisition Cost (CAC) and (2) Lifetime Value of Customer (LTV).
CAC is calculated by adding together for a specified period all costs that went into acquiring customers. This amount is then divided by the total number of customers acquired during the same period, giving you your per-customer acquisition cost.
LTV essentially measures how long a customer is expected to remain a customer of your company and how much money the customer is expected to generate over that period. While the LTV calculation itself is straightforward, LTV is a little more difficult than CAC to calculate accurately in a startup’s early days because you may have to guess at one or both numbers. The closer your guesses are to actual, the better insight you will gain about your company’s sales efficiency.
Knowing your CAC and LTV will help your startup scale at the right time – and not before. The general rule of thumb is that LTV should be at least three times CAC before a company is ready to scale. Premature scaling often leads to poor performance, even failure. Having a favorable LTV to CAC ratio also tends to indicate that a company’s business model is repeatable and sustainable.
In short, know your startup’s key financial metrics. Being able to identify problems early-on will help your startup address business model problems before they become intractable or before your startup burns through its cash reserves. Pivots only happen when problems are identified early enough that the startup still has resources to pursue the modified business model. The metrics can also help you identify when problems are intractable, allowing you to “fail fast” if your company’s business model proves not to be viable.
This blog does not provide legal advice and does not create an attorney-client relationship. If you need legal advice, please contact an attorney directly.