Entrepreneurs face a host of challenges in growing a startup sustainably, however can go a long way to ensuring success by keeping tabs on key financial metrics.
Writing on Medium, Appster co-founder Josiah Humphrey explains that measurement should be a key consideration for startups seeking to ensure their business model is sound and will be scalable over time.
Humphrey lists four key financial metrics that he believes all founders should track closely: fixed versus variable costs, breakeven analysis, the acquisition cost and lifetime value of customers, and cashflow forecasts.
Fixed versus variable costs
Humphrey explains the total cost of running a business, consisting of the aggregate amounts of fixed costs and variable costs, is “one of the most important pieces of financial data” that startup founders need to understand.
“Understanding your total cost is crucial for various reasons, including the fact that the amount of money your business spends impacts whether, and if so then when, you can turn a profit (and how much that profit will be),” he says.
Costs will have a defining impact on how long a company can survive without bringing in stabilising revenue, with a startup’s ‘runway’ calculated by taking its cash balance and dividing it by a projected burn rate (the monthly rate at which a business is losing money), Humphrey advises.
“That burn rate explicitly reminds you that your startup will indeed run out of money at some point in the future if you don’t eventually start bringing in sufficient revenue”, says Humphrey, adding that understanding your company’s burn rate can also be important when attracting investors.
Operating as lean as possible, making fixed costs more efficient and increasing revenue are three ways to extend a startup’s burn rate, Humphrey writes.
Startups should also calculate and monitor their breakeven point, or the point at which revenue matches expenses, as this will allow them to work out a range of other important financial metrics, says Humphrey.
This includes: how profitable a product line is; how far sales can decline before losses start to be incurred; how many units need to be sold before a profit is made; how reducing price or volume of sales will impact profits; and how much of an increase in price or volume of sales will be needed to make up for an increase in fixed costs.
Having completed a breakeven analysis, Humphrey says it is important that startups then consider: whether a sales target is realistic; when they anticipate being able to hit the target; the resources they will need to get there; and how cash will be burnt through in the meantime.
Customer acquisition and value
Humphrey observes that “companies that successfully implement repeatable and scalable business models then begin securing true sales and marketing efficiency”, and this efficiency measured by looking at acquisition cost and lifetime value of customers.
Customer acquisition cost (CAC) is the total cost of convincing a potential customer to buy a product or service, while the lifetime value of customer (LTV) is the projected revenue a customer is expected to generate during his or her lifetime. In successful companies, the LTV is higher than the CAC.
Getting the numbers right is critical, and startups should avoid premature scaling, says Humphrey.
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“In essence, premature scaling is an attempt to massively expand and grow your new company before you have successfully hammered out the intricate details of a repeatable and scalable business model,” he says.
“In other words, failing to nail down the specifics of your CAC and LTV can facilitate premature scaling and, thus, startup failure.”
Cash flow forecast
Cash flow, or the amount of money going into and out of a business, is Humphrey’s fourth key metric as it is “the blood of every startup organisation”.
Humphrey recommends entrepreneurs regularly undertake cash flow forecasting, which provides “the key data you require to ensure that your startup doesn’t burn money faster than what you need in order to stay in business”.
“Cash flow projections can’t, of course, predict the unpredictable but they can alert you to foreseeable potential hazards,” Humphrey advises.
“Whilst it might be best to let a professional account carry out the quantitative analyses, it’s still important that you as a founder grasp the principles of cash flow forecasting.”