Four key financial metrics & tools that drive your business forward
90% of startups fail in the first five years. Only 40% turn a profit. It's well-documented that most startups fail due to money-related issues. Sound financial planning is crucial particularly when we are living in uncertain times.
Most startups fail because their business model and economic growth are unhealthy and cannot sustain over the long-term. How can you ensure is sound and poised for growth? this is where measurement comes into play.
- Cash flow forecast
Having an excellent cash management strategy over your daily/weekly/monthly/annually trading is one of the most most important measures that matters to your debt to income ratio.
Positive cash flow translates to more money coming into your business than going out. And negative cash flow is the opposite of this. Cash flow is the lifeblood of any startup because no cash = business failure. It's vital that you understand and consistently track your cash flow numbers through a cash flow projection to determine the health of your business.
Developing a cash flow projection will enable you to carefully plan your working capital more effectively, so you can pay your operational expenses on time and maintain positive cash flow, making you more attractive to investors.
Looking after cash flow will also give you the ability to invest more capital in expansion by hiring more people, opening new territories, or improving your product or services. Taking this approach will propel your business to the next stage of growth and away from the financial downfall associated with startup life.
- Fixed vs variable costs
Tracking your total costs of running your business over time it vital to your business. Total costs include all that are fixed and variable of a defined period of time.
These are costs that do not vary from selling one or more units of your product or service. Types of fixed costs include professional fees for any legal or accountancy services for starting or running a business. Also, rent, insurance, loan repayment or recruitment and training fees for staff.
Cost that vary with the company's volume or production of goods and services. These costs can increase or decrease depending on production. Examples include direct materials, packaging and shipping, labour, sales commissions and so on.
Understanding your total costs will impact when you turn a profit. Outgoing money influences the time your company can survive without stabilising revenue. This is called runway.
Here's how to calculate your runway (which you can easily create using Canaree)
Runway = cash balance of £300,000 / burn rate of £35,000 a month.
Your runway is 10 months (until you run out of money)
Burn rate is tracking how quickly your company is spending money. You can focus on burn rate because it allows growing businesses to set realistic timelines on how long before you run out of money.
Investors will look at burn rate and measure it against future revenue when thinking about investing. If the burn rate is greater than what you've forecasted if the company's revenues are not growing rapidly enough, then investors may thing the company isn't a good fit for investment.
- Breakeven analysis
One of the biggest challenges facing startups is when it will become profitable. Where does the money come from (i.e. sales) and how much will you need (the amount of fixed and variable costs)? Answers to these questions can come from knowing your breakeven point. Once you hit breakeven point is where you begin to accumulate profit.
There are many advantages to calculate your breakeven point. With this understanding, comes the following advantages:
- How profitable your product is
- How many units you need to sell before profit
- How long you can experience decline in sales
- Impact of increasing or reducing prices on profit
To calculate breakeven point:
Breakeven point = fixed costs / unit selling costs - variable costs)
- CAC to LTV ratio (unit economics)
"A startup is an organisation formed to search for a repeatable and scalable business model" - Steve Blank, father of Lean Startups
Startups that become repeatable and scaleable do so because they successfully measure CAC and LTV.
Customer Acquisition Cost (CAC) - The average expenses of obtaining a customer. You calculate this by dividing costs spent acquiring the new customers (marketing/advertising) by the number of new customers during a defined period.
Example: spending £5,000 per month (January - March)/ acquire 30 customers CAC = £111
Customer Lifetime Value (LTV) - is the average revenue a single customer is predicted to generate over the duration of their account. The average lifetime value of your customers is the average monthly revenue per customer adjusted for monthly churn and gross margin. Calculating LTV can also be achieved by using annual recurring revenue and annual churn.
Example: If your service costs £300 per year and your average customer stays 3 years, then your LTV is £900.
Once you have both LTV and CAC calculated individually, it's easy to know the ratio between them. All you do is divide LTV by CAC
How to calculate LTV to CAC ratio.
(£) LTV / (£) CAC = (#) LTV to (1) CAC Ratio
If your LTV is £900 and CAC is £166 then your LTV:CAC ratio is 5:1.
LTV is calculated differently for types of businesses, for example: SaaS, Ecommerce, mobile apps. Check out Gekko Board for more on this
As a business owner, there are some key financial modelling terminologies that you need to familiarise yourself with. Many of you may use Excel spreadsheets and find it difficult to interpret the insights from the numerical data provided, to make informed, well-educated decisions to drive your business forward. They are;
- The Profit and Loss (P&L) statement; a report of the changes in the income and expense accounts over a certain period. (monthly and yearly) being the most common.
- The Balance Sheet; which records the balances of all assets and liability accounts at any given point in time (coming soon).
- The Cash Flow Statement; a report of the changes in all aspects of the accounts. (income/expenses and asset/liability) to determine how much cash the business is producing or consuming over a certain period. (monthly and yearly) are most common.
This is just a smattering of the financial metrics we offer at Canaree. We thought they cold be top of mind. Some of the questions you may be asking; as a founder, why do I need to keep track of my P&L? Can I have a good or a bad P&L? Why will an investor ask me about this? In our next blog article, we will focus on how to make certain your P&L, Balance Sheet, and Cash Flow Statements are attractive for your investor.
With Canaree, you can build a financial model with advanced forecasting tools in minutes. It is easy-to-sign up and get started. We have your back with ready-made business templates depending on the type and stage of your company.
We've simplified the process so you can create beautifully designed models that fit nicely with your investor deck or for an important meeting. On top of your numbers, we also analyse them. For example, if your unit economics or expenses look off, we recommend ways to improve them. All of the advice you would get from a financial advisor, including scheduling a call with one of our financial advisors are included in the product! Excited to learn more about Canaree? Signup for free today!