Entrepreneurs have no trouble coming up with new products and business models. But when it comes to crunching the numbers and making sure the business isn’t spending more than it makes—well, that’s what CFOs are for.
Besides profit and revenue growth, spend management is essential to startup success. With insights gleaned from a few key metrics, you’ll be able to assess your company’s financial health. You’ll know whether or not you’re investing the right amount of funds in certain areas based on the return on investment (ROI). And you’ll be able to identify critical aspects of your operations that need to be improved.
About 20% of new startups fail within the first year of operations and a good proportion of them fail for capital-related reasons. Either they lacked the capital to sustain their operations or they scaled too fast for their cash flow to handle. Whatever the reason, it was a matter of miscalculation or a lack of awareness.
Proper spend management can help you get your business past the first year hurdle and then some. Here are eight key metrics every CFO needs to assess to ensure healthy company expenditure.
Revenue is a core metric in any business and usually a point of focus for company leaders. It refers to the sales generated when customers buy your product, minus the cost of returned or undeliverable items.
When it comes to assessing revenue, the higher the better. Most CFOs pay attention to year-on-year revenue growth. This will tell you how much your company has developed in the past year and if you’re on the right track to meeting your long-term goals. Revenue will also reveal which areas of your business are doing well, whether it’s your content marketing strategy or your sales lead management.
But revenue is only one side of the coin—consider it a backdrop to company expenditure. The number of sales you make is moot if you’re continually spending more than you’re bringing in.
Another important metric is gross margin. Typically expressed in percentage points, you can calculate gross margin by taking the company’s net sales revenue and deducting the cost of goods sold (COGS). This will tell you much revenue a company retains after incurring the costs to produce the goods in the first place. You can think of it as the “mark-up.”
This figure can provide insights on how production costs relate to revenue—whether you need to cut down on labor costs, look for cheaper alternatives to supply materials, or increase your rates. It can also tell you if your company is being efficient with every dollar spent.
The gross margin represents the portion of each dollar of revenue the company retains as gross profit—the higher the percentage, the more the company saves on capital. These savings can then be used to satisfy other expenses, such as debt obligations, administrative fees, or dividend distributions to shareholders.
Customer acquisition cost (CAC) is especially important for early-stage startups that are still growing their customer base. It refers to the cost of acquiring new customers and is usually allocated to sales and marketing expenses. You can calculate your CAC by dividing your total sales and marketing costs by the number of customers you acquired in a period of time.
Dubbed as the “startup killer,” CAC is an often overlooked aspect of business expenditure. Optimistic founders believe that a good product will inevitably attract customers and underestimate the cost of sales and marketing tools. As a result, they end up shocked by the cost of acquiring one customer, thereby impeding their ability to scale.
CAC is directly related to CLV, or customer lifetime value. CLV refers to how much you earn from a customer while he or she is a patron of your business. For example, the CLV of a coffee drinker could be $10,000 if that customer continues to drink $4 coffee from your establishment everyday for seven years.
In order to make a profit, your CLV should be higher than your CAC. Marketers suggest your CLV should be at least three times higher than your CAC in order to be sustainable. And ideally, you should be able to recover your CAC in 12 months. If your CLV is lower than your CAC, then you’re spending way too much on acquiring customers and losing money.
This is sometimes the case for companies that are scaling too aggressively. According to the 2012 Startup Genome report, “premature scaling” is one of the most common reasons that startups fail.
Churn rate (also referred to as attrition) refers to the percentage of customers that stay with and leave your business over a given time period. Low churn rates are indicative of happy customers, a sticky product, and capital efficiency.
Churn rate is particularly important for subscription-based business models that rely on recurring monthly revenue. If customers churn at a high rate, then it will impact your cash flow and make it difficult to recover your CAC. At this stage, it’s important to analyze customer churn and find out why and when it happens.
The good news is that it’s far easier to win back a lost customer than it is to acquire a new one. So if you find that you’re losing a number of subscribers, this is your chance to fix things up and get them back on board.
Overhead costs refer to the fixed costs associated with running your business but are not directly related to creating the product or service. These are the expenses that you need to pay for regardless of your business’ performance. This includes rent, utilities, insurance, office equipment, and the like.
It’s important to take note of these costs as these contribute to how much a company must charge for its product or service to make a profit. If you track them on a monthly basis, you’ll be able to see where the spending occurs in your business and make better-informed decisions.
For example, you can see that rent is one of the biggest money-sucks in your expense sheets—this can help you decide whether it’s worth your time to relocate to a cheaper one.
Burn rate refers to the amount of cash that goes out the door when your business’ cash flow is negative. For example, if your company has $500,000 at the start of the month and only $450,000 by the end of it, then your monthly burn rate is $50,000.
While it might sound alarming, most early-stage startup companies deal with financial loss before they can start generating their own income. This is because they are more focused on growing their customer base and improving their product in the initial phase of their operations. Investors usually take burn rate into account when assessing whether a startup is a worthwhile investment.
However, running out of cash is one of the top reasons startups fail. And staying on top of your burn rate at all times is critical for long-term survival.
In relation to burn rate, runway is the amount of time your company has before it completely runs out of cash. It is usually expressed in terms of months. You can calculate your runway by dividing your cash by monthly burn. For example, if you currently have $100,000 in capital with a monthly burn rate of $25,000, then your runway will be four months.
Think of your runway as a sort of timer—it’s the amount of time you have before you need to bring in stable revenue or seek investment. This affects your business in a number of ways.
Too short of a runway puts too much pressure on you to bring in more money and could put your business in financial distress. Too long a runway and there wouldn’t be enough pressure for you to perform over the given period.
Venture capitalists suggest that 18 months is the magic number.
These key metrics can give you tons of insight into how to improve your business. Company expenditure can speak volumes about the current state of your business and your target market. But with so many different moving parts, it becomes difficult to keep track of all the numbers let alone make sense of them.
This is where a spend management solution comes in. Spenmo is your very own Cloud CFO that can help you gain control and visibility over company spending.