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How to use startup metrics to drive your business
Welcome to the wonderful world of startup metrics. You’re about to learn how to put yourself in the driver seat of your startup and show investors that you’re in control while you’re at it.
What are startup metrics?
As the name suggests, they’re financial measures for your startup.
Traditional finance measures – like profit and loss and balance sheets – just don’t cut it in startup land. By the time something shows up in them, it’s usually too late to do anything.
Don’t get us wrong, you still need a P&L and balance sheet to run your business. But you also need to use the right startup metrics to lead the way and highlight any problems and opportunities early enough to (hopefully) do something about them.
Not to mention, if you’re raising capital, investors want to see your startup metrics in action. They want to know where you’ll use their money and how that will affect your key numbers.
So, read on for what startup metrics to measure and how to do it.
The main startup metrics to track
Firstly, we should acknowledge that when you’re just starting out, it’s really only about revenue and profit.
But pretty quickly as your business evolves, you need to track key startup metrics. They can vary, depending on the nature and stage of your startup, but as a starting point we recommend tracking the following.
Startup financials (as opposed to the P&L and balance sheet):
- Cash burn
- Cash runway
- Recurring revenue
- Customer acquisition cost (CAC)
Growth and expansion:
- Customer lifetime value (LTV)
We’re not going talk much about sales pipeline metrics, conversion ratios or cohort analysis as those are a whole ‘nother world (and probably a future blog 🙂 )
So let’s break those six metrics down.
1. Cash burn
Also known as burn rate or just burn. This is sometimes confused with cash runway but it’s different (more on this below).
Burn rate is how fast you’re spending your cash.
It’s especially important in early stage startups, which often fail because they begin running out of cash and don’t leave enough time to raise funds or reduce expenses. We recommend tracking it beyond the early stage too because it’s important to know how fast you’re spending your money.
Cash burn is usually expressed as a monthly amount.
The simplest way to think about and calculate your monthly cash burn is to look at the most recent month’s spend, and consider whether it’s a ‘normal’ month spend going forward. You’re roughly trying to come to the view of: If we keep spending at the current (adjusted) rate of $x / month, how long can we last (the runway).
It’s worth noting that while you’ll likely get the data from your P&L, the idea is not to get this strictly correct from an accounting perspective but rather to form a quick, somewhat subjective view of continued expected spend going forward.
So to calculate your cash burn:
Take your cash spend from the last month from your P&L. Then adjust it for any abnormal spend that may have happened and for any future expected spend (such as if you’ve just hired a new developer).
2. Cash runway
Your cash runway is how much time you have left (usually in months) before you run out of money.
This is especially important in startup land where founders are often operating at a net loss while in development or set up mode. But arguably, it’s important for all small and medium sized businesses because it keeps you focused.
To calculate cash runway:
Divide the money you have in the bank by your cash burn (see above).
For example, if you’re spending $10,000 a month and you have $100,000 left in the bank, you have 10 months of runway left.
This assumes that all other things are equal in that 10 months so if you have some bigger expenses one month, the runway would reduce. It’s not a perfect measure but it’s a quick snapshot worth tracking.
3. Recurring revenue
Not all startups will have recurring revenue but if you do, you need to track it.
Investors love businesses with recurring revenue because they see them as buying into a ‘guaranteed’ future revenue stream, just like an annuity. Just watch out for churn as discussed further down.
You can track monthly recurring revenue (MRR), which is typically used for SaaS startups, or annual recurring revenue (ARR) if your business model is based on larger dollar amounts instead of high sales volumes.
Both MRR and ARR track only revenue that recurs, such as subscriptions or a monthly fee. So if you’re charging customers a set up fee for example, you need to exclude that.
How to track monthly recurring revenue (MRR)
At some level, you need to be able to identify which of your products and services are recurring.
For example in our own business, we might have a once-off set up fee and ongoing monthly recurring bookkeeping fees. Ideally, you would identify the nature of each product (once-off or recurring) in your billing system. Then you can use your billing data to summarise just the recurring revenue, to determine your MRR.
But wait there’s more …
While it’s great to know what your total MRR is, as you become more sophisticated you’ll likely also be interested in monitoring changes in MRR.
This graph shows some of the things you might want to look at.
In more detail, they are:
- New business MRR – how much of your MRR in the latest month comes from brand new customers
- Expansion or contraction MRR – how much of your latest MRR comes from upgrades (for example where someone upgrades from a bronze to a silver subscription) or downgrades
- Churn – we describe this in more detail below but basically it’s a lost customer
All of these provide additional insight. And you need to be collecting and analysing data at the individual customer and even product level to get to them.
Sometimes people also track average revenue per user (ARPU). To calculate this, go:
MRR / no. of customers.
How to track annual recurring revenue (ARR)
The slightly confusing thing about ARR is that it can stand for two things – annual recurring revenue and annualised run rate. Here’s the difference.
If your business just has MRR revenue, then on an annualised basis you’d expect that for each year going forward at a given point in time you would earn 12 x the latest MRR. This is the annualised run rate.
But, if you also sell products for an annual subscription – a quite common example is ‘buy 12 months upfront and get one month free’ – then these are really their own product type and you should identify and track them separately. So when presenting the recurring revenue for these types of products, you could show (for example):
Monthly recurring revenue (MRR) = $10,000 per month
Annual recurring revenue (ARR) = $25,000
Annualised run rate = 12 x MRR + ARR
Churn means a lost customer. For example, a customer signs up for a subscription and then leaves you later on – that’s churn.
Like those times when Telstra tries to sign you up for your next 24 month mobile phone plan and you decide to change to someone else. Funnily enough, telcos are the first ones that really nailed how to track these kinds of metrics!
Churn can be measured in terms of dollars and in terms of customers, which is why you might hear terms like dollar churn and customer churn. For example: I lost two customers last month and $200 in monthly subscriptions.
Here’s how to calculate customer churn rate:
Number of lost customers in a month / number of total customers in the previous month
(then multiply the answer by 100 to give you the percentage).
For example 2 lost customers in January / 200 total customers from the previous month = 0.01
Then 0.01 x 100 = 1% customer churn rate.
We usually recommend tracking monthly churn and also churn for the last 12 months, so you can zero in on any monthly spikes and diagnose what could have caused them.
And it’s worth noting that if you know your churn rate, you’ll know your retention rate too. For example, if your churn rate is 2% of customers monthly, you’re retaining 98% of your customers monthly.
And here’s how to calculate dollar churn rate:
MRR* lost in a given month / MRR* at the beginning of the month
(then multiply the answer by 100 to give you the percentage).
This will give you gross churn. It’s worth calculating net churn too, which is:
MRR* lost in a given month – MRR* gained from upsells that month / MRR* at the beginning of the month
(then multiply the answer by 100 for the percentage).
*MRR = monthly recurring revenue. You can replace this with ARR (annual recurring revenue) if that’s more appropriate for your startup.
5. Customer acquisition cost (CAC)
Yep, this is the cost of getting a new customer.
Especially for subscription-based startups: the staff and marketing costs of acquiring new customers is an upfront cost and you only receive the payback for it over time. If you’ve validated your business model and you’re ready to hit the growth accelerator, you’re especially raising capital to cover these upfront customer acquisition costs – that’s why investors are interested in understanding this metric more.
As the team at Andreesson Horowitz says, not all CAC metrics are created equal but there are two main ways to calculate CAC, and you should probably do both (especially if you’re talking to investors).
The simplest way of calculating CAC is what’s called blended CAC, which is:
Your total monthly acquisition cost (that’s everything you’ve spent, such as advertising, referral fees, credits or discounts) / total number of new customers acquired across all channels that month.
Investors might also want to see this broken down into just your paid CAC, which helps show how well your paid advertising is working and whether it’s profitable. To calculate this, go:
Total monthly acquisition cost / the number of new customers you acquired through paid marketing that month.
As your startup evolves, you and your investors are also likely to want a breakdown of paid CAC per advertising channel. For example: the CAC for a customer acquired through a Facebook campaign versus a Google Adwords campaign.
And so you start to monitor each of the ways you’re trying to generate new business and the extent to which each type of activity and channel is effective – doubling down on what’s working and coming up with different strategies if things aren’t working.
6. Customer lifetime value (LTV)
This is a prediction of the net profit from the customer throughout your entire relationship with them.
It helps determine the long-term value of the customer. The main reason to track LTV is so you know how much you can afford to spend on CAC. It also helps you evaluate your customer service. Some people will leave because they don’t like your product/service but others will leave because of your customer service, which is often easier to change!
Here’s how to calculate LTV:
- Calculate revenue per customer (per month). To do this, go:
Average order value * number of orders
- Calculate your contribution margin per customer (per month). To do this, go:
Revenue from customer – variable costs associated with customer (e.g. selling, admin and customer service costs) and yep this takes some thinking about
- Calculate the average customer lifespan (in months). To do this, go:
1 / your monthly churn
- Finally, calculate your LTV by going:
Contribution margin per customer x the average customer lifespan
Like all measures, LTV is not perfect and it can be relied upon too heavily sometimes. So keep it in perspective and remember: It’s a tool not a strategy.
And the bottom line is: If you’re not covering your upfront acquisition costs with your profits, then you haven’t got a long term sustainable business.
If you’re a SaaS startup, read this part
SaaS startups are a bit special – you know it
Which means you need special attention when it comes to metrics.
For SaaS startups, it’s all about the sales funnel. So in addition to the metrics explained above, there are a few others to watch, including:
- Leads – track the leads you’re receiving each month (and where they come from)
- Lead velocity rate – the monthly growth rate of your leads
- Conversion rate – how many leads are converted to sales (sales / leads * 100)
- Velocity – how quickly you’re generating revenue. This captures the amount of time it takes to turn your qualified sales leads into revenue and is expressed as dollars per time period
You can learn more and see some examples of SaaS sales funnel metrics in practice here.
Give me more startup metrics
Sure thing. If you’re feeling in the metric mood, we can’t go past this advice from Andreessen Horowitz.
We also run (free) workshops on startup metrics at coworking spaces in Sydney, Melbourne and sometimes in other states too. Follow us on Eventbrite so you don’t miss out.
Before you go, just a reminder that this isn’t personal advice. If you want that or help with metrics or financial planning for your startup, book a call and we can chat about what you need.
Thanks to The Lazy Artist Gallery on pexels.com for the image.
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