What to Measure – Key Metrics for Start-ups
Traditional accounting methods and timescales don't work for start-up businesses. A lot of start-up businesses are not well-funded. Those which are well-funded can still hit financial trouble if they don't have warning signals in place.
An annual reporting cycle is too long. Even quarterly may be too long, if funding is tight. Some metrics need to be measured daily and weekly so that founders can show investors that they are tracking well.
Profit vs Cashflow
Profit and cashflows are not the same. If you have a subscription model with customers paying 12-months on signing up, for cashflow purposes you have the cash inflow up front. For tax purposes, some of that income is in advance. If your balance date is March and the customer signed on at the start of January, then you have received 9 months in advance. Your profit is not as high as your cashflow because you still have to provide 9 months of services to that customer.
Conversely, if you buy stock upfront or employ staff to fulfil services and invoice on completion with payment on the 20th of the month following, you'll have cash flowing out of the business even if you are profitable.
Here are some metrics which we use frequently with established businesses. Some of these may be useful for start-ups but not all start-ups will find these relevant.
Revenue or Turnover – Sales, expressed in dollar amounts or percentage increase. Are your sales reliant on one or two large customers? Consider broadening your customer base, to spread the risk of losing your biggest customer.
Gross profit – Revenue - Cost of sales. Analyse gross profit by customer or by project. What if you were losing money every time you made a sale to your biggest customer because of the big discounts they received?
Net profit – Gross profit – Operating expenses. Expressed before or after tax.
Return on investment – Net profit / Owners' equity. This measure tells you how well your investment is performing.
EBITDA (Earnings before interest, tax, depreciation & amortisation) – Net profit + Interest + Depreciation/Amortisation. Takes the source of funding out of the picture when considering profitability.
Stock turn – Cost of sales / Average inventory. Slow moving stock (a low number) is inefficient as it ties up money that could be used elsewhere. It may point to having the wrong stock or obsolete stock.
Accounts receivable days – Average receivables / Revenue x 365 days. How long it takes to receive payment.
Accounts payable days – Average payables / Cost of sales x 365 days. How long it takes to pay bills. A high number may suggest that a company is struggling to meet its obligations. But on the other hand a low number may suggest that suppliers are unwilling to allow trade terms, so this might also be a warning sign.
Current ratio – Current assets / Current liabilities. Should be higher than 1 to show that a company is able to pay debts as they fall due.
Liquidity ratio or Quick ratio – (Cash or equivalents + Accounts receivable) / Current liabilities. More conservative than current ratio, as it recognises that it can be difficult to sell inventory in a hurry to pay bills.
Start-Up Metrics relating to Customers
Monthly recurring revenue (MRR) – For subscription services, the sum of the monthly fees paid by your customers. Could be calculated as average fee per customer times the number of customers. Net New MRR = New MRR + Expansion MRR – Churn MRR
Customer lifetime value (LTV) – Ave purchase value x frequency x lifespan. How much revenue they can expect one customer to generate over the course of the business relationship. The longer a customer continues to purchase from a company, the greater their lifetime value becomes.
Customer Acquisition Cost (CAC) – total marketing and sales cost to gain a customer over time. Direct costs such as Facebook or Google AdWords, sales commissions, but also indirect costs such as overheads.
Compare LTV with CAC to assess the effectiveness of your marketing spend.
Customer Churn Rate – the percentage of customer who cancel or don't renew their subscription. It's generally cheaper to retain existing customers than to attract new ones so this is an important measure.
Start-Up Metrics when you don't have Customers
Some metrics like gross profit are reliant on sales. What if you're not selling anything yet? Profitability and return on investment are not as important as subscriber numbers, conversion rates and cashflow.
If you can track and measure these, you can prove whether you are performing, even without a sale.
User Engagement – How often they open your app, number of interactions inside the app, how long they spend using it, how many recommend to friends.
Conversion Funnel ratio – How many potential customers move from one stage in your sales funnel to another, expressed as a percentage. For instance your sales funnel may be made up of various stages: website visit, selecting products, adding them to a cart, paying for the goods. This may help you to identify friction, such as difficulties completing a signup form or abandoning a shopping cart because it took too long.
Retention Analysis – How many users return to your app without a given timeframe. See cohort analysis below.
Forecasting and budgeting is critical to making sure that a business survives until the next cashflow injection. Budget your spending in advance and keep to your budget.
Burn rate – How much money you spend a month.
Runway – how long before you run out of money in your bank account based on your burn rate. Compare this with your investment cycle, how long it takes to obtain another cash injection.
Vanity metrics should be avoided in reporting. Vanity metrics are measures which make you look good, but don't help you with decision-making. E.g the number registered users vs the number of users who engage regularly. Just about any measure could be a vanity metric if they aren't driving decision making.
Making Useful Comparisons
Using cohort analysis and AB testing you can provide a truer picture of a start-up's progress. Cohort analysis might be grouping users who started using your app at the same time and comparing the retention rate against an earlier group of users. Ideally you should be seeing a higher retention rate with each cohort.
AB testing might be showing one version of your website to half your visitors and another version to the other half. Then you can see which version is more successful at converting visitors to customers.
You can only manage what you measure, according to Peter Drucker. Make sure that you are measuring the right things on a regular basis, so you can manage your start-up effectively.
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Serena Irving is a director in JDW Chartered Accountants Limited, Ellerslie, Auckland. JDW is a professional team of qualified accountants, auditors, business consultants, tax advisors, trust and business valuation specialists.