Everyone starting a new business understands the basic concept of profit. If you earn more than you spend, the difference is your profit, and the greater the difference, the more money you earn. The most important question is, how to run a profitable business?
First, a profitable business sells a product that people need, use, and pay for. If you're starting a new company, this is probably all you're thinking about, turning your vision into reality by building a startup product that solves customer problems and is worth your financial commitment.
Second, an entrepreneur running a profitable business understands key financial and analytical metrics and how they can influence profits. Those metrics are your key performance indicators (KPIs).
In this post, he'll find nine essential metrics he should know and measure. His KPIs may change as his startup grows. For example, when he launches his startup, new registrations or activations can be an important KPI to assess the validation of his startup idea and the feasibility of the solution in addressing the needs of his clients. As his startup grows, his focus can expand to KPIs like customer acquisition cost, lifetime value, and churn rate.
To see how these metrics can affect your startup's profitability and valuation, run simple business calculations to measure how a change in each of the metrics below will increase or decrease your profits.
The LTV or value Customer Lifetime is the income a customer can generate during the life of their membership. For a subscription product, you can calculate LTV by first determining customer value by multiplying average purchase value by purchase frequency. Multiply the average customer value by the average length of time (in months or years) the customer is retained.
If you know how much money you can make from a customer, you'll have a much better idea of how much money you need to invest to acquire a new customer.
CAC or Customer Acquisition Cost is the money you spend to acquire a customer. When you launch your startup with a new product and an unknown brand, your CAC can be high, but as you understand your ideal customer, find your best performing marketing channel, and get referrals through your early adopters, your CAC can begin to decrease. CAC includes your expenses on sales, marketing, and distribution activities.
Abandonment rate indicates the percentage of your paying customers who subsequently canceled their purchase. This is a metric that you should try to keep as low as possible.
Customer retention is the opposite of churn rate. It indicates the percentage of your paying customers that you retained, who renewed their subscription to your product. High retention means that you are delivering the promised value to your customers and they are happy with your product.
The cash flow measures your costs against revenue, since it captures the money that enters and leaves your business. Positive or free cash flow indicates liquidity with more money flowing into the business than out.
The ROI or return on investment is a metric for calculating the gains or losses derived from an investment. To calculate the return on investment for a new business, project, or initiative, divide your profit or loss by your total investment and multiply the result by 100 to get the ROI in percentage.
The burn rate means the amount of capital a startup is spending or "burning" to finance the operation. A startup's burn rate can depend on the business model, funding, and growth strategy.
Calculating the start burn rate is quite simple. The burn rate is the actual amount of cash your account has decreased in a month. More often than not, it describes a company's negative cash flow. It does not include outstanding obligations, money that has been transferred to another account, or money that is on the way.
Revenue is the money you generate through sales and is a measure of initial performance. However, in many cases, revenue is not an accurate measure of the financial health of your company, since it does not take business expenses into account.
Your net income is the difference between your income and expenses. Paying close attention to your customer lifetime value, customer acquisition cost, churn rate, retention, cash flow, return on investment, and burn rate will help you increase the difference between your revenue and expenses, and thus manage a profitable stratup while understanding the key metrics that play an important role in driving the financial performance of your company.
If you're starting a new business and think it's too early to start thinking about and projecting the above metrics, remember that you can create a product your customers love and still fail. A startup cannot sustain value creation if its most basic and key metrics do not add up. At every stage of your company, as much as you think about your product's value proposition, think about the financial health of your startup.