When starting a business at your own it all begins with that one great idea! You’re amazed that no one has thought about that before. With all your energy you jump into this wonderful endeavor! That’s exactly how the founders at our startup started.
However, what’s often lacking is a financial and risk minded view on how to manage that startup. I will dive into several metrics that are essential to manage a tech startup successfully. Let’s dig in.
Key metrics – How to identify success and red flags
When you are just starting out with your new business it’s important to know how to measure its success. What are the key metrics to be able to know whether you are doing a good job?
It all depends on the type of business. If you are selling cars these metrics will be totally different from an eBay type of platform. For our software-as-a-service (SaaS) type of business these metrics are essential:
- Number of (active) users
- Customer acquisitions costs
- Customer lifetime value
- Burn rate
I will go through these metrics one by one to give you an idea about why monitoring (relevant) KPIs is so important.
Please note, these metrics are just a minimal selection. Your business will probably need several more, but don’t overdo it. Looking at a dashboard with 50 KPIs is not going to help you manage decisively and effectively. Focus on key KPIs that you can really influence so that you can navigate your startup towards success.
Number of (active) users
The success of an platform business is directly connected to the number of users. The number of active users to be precise. Active users are practically your customers. They represent the value of your business. If you provide a service that fully meets the demands of those users and you can charge them for it (with a profit), you are doing great. And if on top of that you are able to show massive growth in active users you are GOLD!
So always keep an eye on active users and your retention rate. If people join your platform and pay your fees but run away after a short period, you better identify the reasons and fix it. So you need to track your active and inactive users over time to see what works and what doesn’t.
Customer acquisition costs (CAC)
You do not get people to join your platform without some sort of acquisition efforts. You need to spend some money to get that snowball rolling and growing. The good thing is that times have changed. You don’t need to splash a lot of money on marketing and hope that you reach your target group.
Today with the use of Google and Facebook, you can minutely target your potential customers. This makes the CAC a very relevant metric. This metric will show you how much it costs to increase your user base.
CAC is calculated by dividing the costs spent on acquiring more customers (marketing expenses) by the number of customers you acquired during the same timeframe. For example, if you spend USD 2,500 on marketing in a specific period and you increase your users with 1,250, your CAC is USD 2.00. With every USD 2.00 you spend you increase your userbase with 1.
If you use the CAC, be aware of the fact that there will probably be a timing difference between when you spent that money on marketing and the increase in users. Increasing your marketing spending in month X does not necessarily mean that your user base will increase in month X as well. This could also be in month Y or Z (or not at all, in which case you need to revise your targeting strategy).
So what’s considered a good CAC? It depends. If you are selling an insurance policy of USD 10 a month, a CAC of USD 50 may be pretty good. Especially if you expect to generate 10 times more revenue and profit from that customers. It all depends on the customer lifetime value. Let’s find out more about CLV.
Customer lifetime value (CLV)
The customer lifetime value (CLV) is first and foremost a projection of how much money you can make from your customers in the future. Of course, along the way you need to verify with historical data whether your projection makes sense, but when you are just starting out that’s probably not possible.
You need to see the CLV together with the CAC. If the CLV is very high, you CAC may be higher as well. Because in the end you will make up for that increased spending in CAC during the lifetime of your new customer.
Building a significant userbase with significant revenues and profits takes a lot of time and effort. Until you succeed you need cash to keep going. A tech startup burns money really, really fast. That’s why I’ve dedicated a separate part of this blog to managing your cashflow and burn rate.
Managing your cashflow and burn rate
Cash is king. That’s one of the most essential elements you need to know about finance. A lack of profit does not lead to bankruptcy, but a lack of cash does! You can have millions and millions in profits but a negative cashflow. Even though that looks good, generally it is not.
Even highly successful startups that grow too fast and have not sufficient funding to support that growth will fail. You cannot pay your employees, suppliers and taxes with profits. You need cash.
A real life example of the importance of cashflow
When I joined this startup there was no management information whatsoever. As with many startups, cashflow is ‘managed’ by looking at the bank account. Coming from a corporate background I was shocked. How was this possible?!
These guys are building a fintech with a lot of money going from one side to the other, and they have no idea where the money goes?! When I raised my concerns the reply was ‘No worries, we still have $X in the bank account’.
I said: ‘okay, but do you know whether there will be enough money tomorrow, the day after tomorrow or next month? When do you need additional funding? Can we realize a minimum-viable-product before we run out of cash?’.
After a moment of silence the reply was ‘Yes… I think so…’.
And that, my friends, is one of the reason why so many startups fail. About 29% of startup failures are the result of running out of cash.
So what can you do to minimize the chance of that happening?
Keep it simple
In the very early phase of your startup you do not yet need a fancy cashflow forecasting tool that you can find in expensive accounting programs such as SAP. Good old Excel will do at first. Starting out in Excel will give you the flexibility to make a cashflow forecast that fits your business model so that you will actually use it.
Once your company grows and you need to professionalize your cashflow forecasting, you already have a blueprint of elements that you want to have included in this new tool. This will save you some time and frustration.
Cashflow and timing
Now that we know that cashflow is important, we need to look at another element. Timing. Your company needs to be around to generate and collect future cashflows. You can have $100K cash coming your way in 2 months but if you cannot make ends meet to pay your employees this month, you’re in big trouble.
That’s why I advise you to not only identify the cashflows but to also identify the timing of those cashflows. Show the cashflows on a month-by-month basis so that you know what’s coming.
Avoid the trap of being to generic. You can make back-of-the-envelope calculations of anything you like, but I wouldn’t take my chances on the future of my company. Try to be specific in identifying cashflows coming in and going out but make it workable. Don’t be overly detailed so that you do it only one month and you stop updating it.
Items I would at least expect in a cashflow forecast are (depending on the type of business):
- Capital expenditures (investments in new platform, warehouse, etc.)
- Financing expenses (interest, repayments, etc.)
- IT expenses (server, laptops, etc.)
- Marketing & advertisement
- Travel expenses
- Personnel expenses
- Tax and accounting expenses
Take the time to build a solid forecast
First of all, Excel is a wonderful tool but can also be very dangerous if not used wisely. It’s very easy to make an error. So I would advise you to build a cashflow forecast using different tabs for each income/expense category.
That way you can go nitty-gritty in an income/cost category tab, but still keep the overall view in a so-called dashboard. You just link the dashboard to the input in the separate tabs.
Also, do not hardcode figures in a formula. Always use references and split out a ‘complex’ calculation in different variables in different cells. That way it’s much easier to see the effect of a change in one variable on the outcome of the calculation.
You can find many different templates online, so if you feel overwhelmed and don’t know where to start, just look around online.
Know what drives the success of your startup and manage the cashflow to make it a reality!
It’s as simple or as difficult as that. You just need to start and spend some time thinking about what you really want to know. Make it explicit and factual. Do not manage the financials of your startup by just looking at your bank account. Please, don’t!
It may seem like a hassle, but it will be worth it. This is just the first step in becoming a solid and profitable startup. Know what drives the success of your startup and manage the cashflow to make it a reality!
What are your thoughts on working in a startup environment? Have you done it yourself? What are your experiences? Please share!
Part 2 of this blog will be all about income statements, balance sheets, etc. So stay tuned next week!