Financial metrics - Analyze the performance of your business
Financial metrics enable entrepreneurs, investors, and other stakeholders to analyze the performance of their businesses. Essential performance indicators provide insights into whether a company is achieving its growth objectives and pinpoint areas requiring improvements. When starting a business, founders understand the notion of profit and that you need to make more than you spend but what are some of the key financial elements you need to know as a startup founder?
1- Customer Lifetime value
CLV or lifetime value (LTV) of a customer is the projected amount of profit a customer can generate for your startup over the course of their relationship with your company. In the easiest of cases, you can calculate the CLV by multiplying the average customer lifespan by your customer value. But there are many ways to calculate your CLV. Example: If your service costs 600.
CLV = Average customer lifespan x Customer Value
2- Customer acquisition cost
The Customer Acquisition Cost (CAC) is the average amount of money a business spends to acquire a new customer. This includes marketing costs, sales costs, and all the other activities required to attract new customers and convert leads into paying customers. CAC is an important metric because it helps you and your stakeholders analyze your sales efficiency and determine your customer profitability.
You can calculate your CAC by dividing the total cost of sales and marketing by the number of customers acquired. For example, if you spend 10. To understand, what should be included in the total cost of sales and marketing, take a look at this great article on Customer Acquisition cost written by Launch’s partner Hubspot.
CAC = Total cost of sales and marketing expenses/number of new customers acquired
3- LTV/ CAC ratio
Once you have calculated both your CLV and your CAC, it is easy to calculate your LTV/CAC ratio. This ratio calculates how profitable a customer will be during their lifetime by comparing the value of a new customer over its lifetime to the cost of acquiring that customer. An LTV to CAC ratio that is less than one generally indicates customer lifetime value is not compensating for the cost of acquiring new customers. A very general guideline for business is a LTV /CAC ratio of 3 or higher is healthy.
LTV/CAC ratio = Customer Lifetime Value /Customer Acquisition Cost
4- Revenue Growth rate
Paul Graham, VC and Founder of Y Combinator once said “If there’s one number every founder should always know, it’s the company’s growth rate. That’s the measure of a startup. If you don’t know that number, you don’t even know if you’re doing well or badly”.
The Revenue Growth Rate measures the month-over-month percentage of change in your startup’s revenue over a specific period of time.
Revenue growth rate = (Second month revenue / First month revenue) / First month revenue) x 100
For example, if you have 3500 in April (second month), your growth rate would be 250% (1000) / $1000 x 100 = 250%.
Even more important than calculating your Growth Rate is calculating and analyzing your Month on month-on-month growth Rate (MoM Growth Rate) and your CAGR (Compounded Monthly Growth Rate).
CAGR is the annual growth rate of a specific metric over a period of time. You can learn how to calculate it in this article from the Corporate Finance Institute.
MoM Growth rate (%)= (Growth rate second month - Growth rate first month)/Growth rate first month * 100
As an easy example, let’s say your revenue grew from 200 in April (second month), your MoM growth rate is (100)/$100 * 100 = 100%.
5- Burn rate
The burn rate helps a company calculate the amount of capital it is pending or “burning” to cover its operating expenses for a given period of time (generally by month). Operating expenses include regular outgoings such as salaries, rent, utilities, loans you pay back in regular installments, etc. This metric shows how fast you are consuming your reserves and how long you can survive before running out of money.
Burn rate = Sum of all operating expenses
6- Runway
Once you have calculated your Burn rate, measuring your runway is easy. The Runway defines how long your company can survive if your income and expenses stay constant or the number of months you have left before you run out of cash.
Runway = Total amount of cash you have on hand/burn rate
For example, if you have 10,000 monthly for all your operating expenses (burn rate) your runway is 10 months. If the cash coming in is growing or if your expenses fluctuate every month, you will have to do a monthly forecast to calculate the number of months of cash that you have left.
7- Churn rate
The churn rate indicates the percentage of your paying customers who stop doing business with your company over a certain period of time. This is a metric that you should aim to keep as low as possible as it is one of the key metrics that indicates if your customers are satisfied with your service or not.
Customer churn rate = (Number of customers lost during a time period / Number of customers at the beginning of this same period) * 100
For example, if you have 250 customers at the beginning of April and lose 10 of them by the end of April, your monthly customer churn rate is 4%.
8- Recurring Revenue
Have you already seen the metrics MRR, QRR, or ARR? All of them are tied to the notion of recurring revenue and are fundamental measures of how good a business is doing and how fast it is growing. It is the most commonly used revenue metric for early-stage startups.
The MRR (Monthly Recurring Revenue) is the average recurring revenue generated by paying subscribers on a monthly basis. ARR is the equivalent of the MRR but calculated for a year and the QRR for a quarter.
MRR = Average subscription revenue per customer owed per month* x total number of customers
- Also called ARPU - Average Revenue Per User (number of monthly subscribers divided by average revenue per user)
ARR = 12 x MRR**
** Might be more complicated to calculate if not all your customers are on a one-year contract. Get more information on how to calculate your ARR in this scenario here.
For example, if your business has 50 customers and each of them spends 5,000, and your ARR = $60,000.
We have listed above some of the most important financial metrics every startup founder should know. If you want to calculate some additional metrics you can take a look at this article from BetaKit or this other one from A16Z.
Suggested Prompts
How can understanding and optimizing the LTV/CAC ratio directly influence a startup’s marketing and sales strategies?
In what ways might analyzing churn rate impact a company’s product development and customer retention efforts?
How can startups use revenue growth rate, MoM growth, and CAGR together to make more informed financial forecasts and business decisions?
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Introduction and Onboarding
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CHAPTER 1 : CUSTOMER DISCOVERY AND LEAN CANVAS
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Chapter 1: Customer Discovery and Lean Canvas
Defining Your Startup Idea
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Team and background
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Competitor analysis
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The Lean Canvas
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Talk To Your Customers
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#1 Determine your value proposition
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Prototype
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User testing: why is it important?
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CHAPTER 5: FUNDRAISING & FINANCES
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Chapter 5: Fundraising and Finances
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Financial metrics - Analyze the performance of your business
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