For companies large and small, the ability to unlock data-driven insights is becoming the industry norm. As attitudes towards metrics-based business analysis have become more focused in the past decade, there is increasing pressure from internal and external stakeholders to monitor key financial metrics from a company's very early stages.
While there are fairly standardized formats for financial statements, a company should further customize financial reporting and emphasize those that fit its business. For example, a manufacturing company may be more concerned with labor productivity and quality control issues while an e-commerce company has a special interest in subscriber turnover or conversion ratios. Given the different factors that influence early-stage companies, we’ve outlined 4 Key Performance Indicators (KPIs) that you should consider tracking regardless of industry.
1. Cash Burn
Key Questions Answered: Is my business improving its ability to generate cash flow? How long can I operate before I run out of my current cash reserve? When and how much do I need to raise of additional funding to sustain my core operations?
How to Calculate:
+ Net Income / Net Loss
+ Non-Cash Expenses (Depreciation, Non-Cash Interest, etc.)
- Increase in Net Working Capital
- Increase in Capital Expenditures
Analysis: Cash Burn is the negative operating and investing cash flow of a company. With your current cost structure and cash reserves, Cash Burn will show how your costs are behaving in comparison to your revenues and project your company’s ability to become cash flow positive. This metric signals to investors how much leverage you have in a negotiation, if any. Not tracking cash burn on an ongoing basis can lead to a situation where there is a mad dash to raise cash, which can potentially result in unfavorable financing terms. This can become a huge diversion from key business operations for the core management team.
As a stand-alone metric, cash burn does not indicate the specific drivers behind negative cash flow and whether lagging revenues or increasing operational expenditures are leading to a cash burn that is higher than expected. Additional bottoms-up analysis should be performed to determine the specific drivers impacting ongoing business operations.
2. Gross Profit Margin
Key Questions Answered: How much am I making per unit of product / service provided? Am I pricing my product / service correctly? How does my company compare to competitors?
How to Calculate:
Gross Profit Margin = (Revenue – Cost of Goods Sold) / Revenue
Analysis: The Cost of Goods Sold (COGS) or Cost of Revenue for a SaaS company, breaks out the direct costs of generating revenue (or providing a service) before considering the operational costs. The cost of hosting, direct product upkeep, internal engineering support, and customer service should all be included, because without these essentials your product cannot be delivered to the customer.
Gross profit margin is very useful for making comparisons with other similar companies, since each company has different sets of operating costs. A high gross margin represents a profitable product and indicators that more money is available for growing the business by investing in sales and marketing resources. Therefore, a company with a healthy gross margin but lower revenues may have better growth potential than another company with higher revenue but a low gross margin.
3. Customer Lifetime Value (LTV)
Key Questions Answered: What is the future net profit from this customer over the duration of the relationship? How much can our company spend on customer acquisition?
How to Calculate:
Contribution margin per customer (per month) = revenue from customer minus variable costs associated with a customer. Variable costs include selling, administrative and any operational costs associated with serving the customer.
Avg. life span of customer (in months) = 1 / by your monthly churn.
LTV = Contribution margin from customer multiplied by the average lifespan of customer.
Analysis: Lifetime value is the present value of the future net profit from the customer over the duration of the relationship. This is a key distinction to make, because a common mistake is to associate LTV as the present value of the revenue or gross margin associated with a customer. A true LTV calculation must also take into account other variable costs associated with selling or operational costs associated with servicing that customer.
Once calculated, LTV can and should be compared to other metrics like Customer Acquisition Cost (CAC). The comparison of LTV/CAC helps to put into context the net present value of future profits vs. what it actually costs to obtain and service this customer. A general rule is that an LTV/CAC ratio should be around 3:1. It is at this inflection point where there is a level of balance between customer value and the spend associated with acquiring a customer. In fact, a higher LTV (such as 5:1) may even denote that your company is spending too little on customer acquisition, and could indicate that you are potentially losing out on business due to a lack of customer spend.
4. Deferred Revenue
Key Questions Answered: What is the cyclicality of my SaaS contracts? When does my business gain an influx of cash? How can I better manage the volatile nature of my SaaS contracts?
How to Calculate:
Deferred Revenue per Contract = Total Contract Value – Revenue Recognized on that Contract)
Analysis: Deferred Revenue or Unearned Revenue, is advance payments a company receives for products/services to be delivered at a later time. Deferred revenue is primarily recognized on the balance sheet as a current liability, and once the product or service is delivered, then the portion of deferred revenue delivered is transferred to the income statement as revenue.
Early-stage SaaS companies can be extremely reliant on these types of upfront payments as they provide positive cash flow to the business, but they can also be extremely volatile in nature. It should also be noted that even though a company receives cash upfront, these cash payments must not be falsely equated with revenue. Once revenue is actually recorded, this is often a lagging indicator of company performance. For companies that structure contracts in this format, management needs to account for and continually revise their forward-looking sales projections to accurately project the associated business risk and expected revenue.