Launching a startup is often a precarious endeavour. This is why tracking the business’s financial health is essential to growth. That is, when a decision needs to be taken, the leadership has to know and understand the company’s key objectives and have a clear vision of how they intend to reach them. If the current situation isn’t under control and you’re not steering the organisation in the right direction, you are not going to be able to manage risks and guarantee the venture’s survival and its financial health.
This is so much the case that there are particular parameters that you need to control to ensure a robust financial structure and financial health. Even the most experienced entrepreneurs have been known to neglect these metrics, so it is crucial to have a business plan that clearly identifies these parameters. Here, we provide the essential brief to the four metrics that provide a proper overview of the financial health of a startup.
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One of the main reasons many entrepreneurs need to wind up their venture is due to a lack of cash. Even though this condition is caused by a variety of reasons, it can be avoided by carefully controlling cash flow. Together with the burn rate, this is arguably the most important parameter to understand the financial health and sustainability of the organisation.
This metric is known as ‘runway’. This is defined as the amount of time a company has before it runs out of cash. It is usually measured in months, and in other words, it quantifies how many months the company has left until the cash flow situation becomes terminal. A good metaphor is how many kilometres a car can drive before it runs out of petrol. A long journey without a fuel gauge would be risky business.
2. Burn rate
On the other hand, there’s the burn rate. It measures how much money you “burn” per month. In other words, how fast do you spend your cash and why? What’s the biggest drain on resources and how could these processes or activities be made more efficient? This is a key indicator of how efficient our operations are and where you can make savings.
Along with runway, these are the two parameters that are key to understanding your spending and the efficiency of the entire operation. With full visibility over this metric, leadership can properly control and manage the company. Namely, they can make impactful decisions over expenses, whether it be increases or reductions – whatever makes the startup run better and bring key objectives within reach.
3. Customer lifetime value (CLV)
Customer lifetime value (CLV) is key to analysing whether or not the attraction model the business currently has is profitable. Essentially, what CLV measures – as the name indicates – is how much value a client adds throughout their relationship with the business. The CLV forecast will specify the revenue the company aims to obtain from every user. This is why it needs to be as exact as possible, as it will provide a clear indication of the venture’s potential profitability.
Moreover, it is a useful tool to assess the company’s competitive advantage in the market. Oftentimes, the formula is simple: a greater number of clients means a greater competitive advantage. This is because knowledge is power. With more clients, you have a deeper understanding of the market segment and their needs. As the offering becomes more refined, it becomes harder for the client to stop using that product or service, increasing their CLV, improving the financial health and making the business more sustainable.
4. Cost of acquisition (CAC)
Finally, we have the cost of acquisition or CAC. This is the initial investment a company makes to gain a client through paid channels, who afterwards will benefit the company via their CLV. This metric will shed light on the net value of each acquisition, that is, which are the negative CACs (money lost) and which are the positive (profit earned).
In basic terms, the viable equation is CLV > 0. It is key to compare the CLV to CAC since they explicitly demonstrate if a client is profitable or not. If the money invested in gaining them is greater than the return, your energy and money are better spent elsewhere – simple as that.
Keep things running smoothly
To conclude, we’ll reflect once again on the car metaphor. On the dashboard are various dials that give you visibility over the vehicle’s functioning. Without them, you’d be in a lot of difficulty; after all, if you don’t know how fast you’re going, you don’t know when you’ll reach your destination. Equally, you need to know that you have sufficient fuel to make it. Meanwhile, the engine warning lights and temperature gauge keep you informed ahead of a potential breakdown.
A startup is just the same. This is why a business plan can’t only be a document of elegant prose about company vision and values – it needs to be backed up by the figures. These figures have to be measured and updated on an ongoing basis, giving an accurate indication of the venture’s sustainability and its financial health. All in all, by tracking and forecasting these parameters, you will be able to support healthy growth, as well as having the visibility to take corrective actions. Think of it as a smoothly running car – without the figures, you’re on the road to nowhere.
A final note: Take control of costs with freelance talent
There is one shrewd strategic measure you can take to keep your cash situation under control when launching a startup – leveraging freelance talent. With the flexibility and value that freelance workers offer, you can get the expertise you need on-demand, without the financial stressor of hiring expensive talent. Click here to learn more about the case for freelancers at the launch of a startup, or, browse Outvise’s portfolio to find just what you need.
UpBizor is a one-stop solution. They offer support in everything your company needs throughout the different stages of its life. Thanks to their expertise as investors in Venture Capital, they are a team of professionals that includes everything a startup needs to grow and succeed including being top in finance, legal, talent, and much more.