Everyone starting a new business understands the basic concept of profits. If you are making more than you are spending, the difference is your profit and the bigger the difference, the more money you make. The most important question is, how do you run a profitable business?
First and foremost, a profitable business sells a product that people need, use and pay for. If you are starting a new venture, this is probably all that you are thinking about, turning your vision into reality by building a startup product that solves customers’ problems and is worthy of their financial commitment.
Secondly, an entrepreneur running a profitable business understands the key financial and analytics metrics and how they can influence profits. Those metrics are your key performance indicators (KPI).
In this post, you will find nine essential metrics that you should know about and measure. Your KPIs can change as your startup grows. For instance, when you launch your startup, new registrations or activations can be an important KPI to evaluate the validation of your startup idea and viability of the solution in addressing your customers’ needs. As your startup grows, your focus may 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 your profits will increase or decrease with a change in each one of the metrics below.
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1. Customer Lifetime Value
LTV or lifetime value of a customer is the revenue that a customer can generate for your startup over the lifetime of their membership. In a subscription product, you can calculate LTV by first determining the customer value by multiplying the average purchase value by the purchase frequency. Multiply the average customer value by the average period (in months or years) that the customer is retained.
If you know how much money you can make from a customer, you will have a much clearer idea of how much money you should invest in acquiring a new customer.
2. Customer Acquisition Cost
CAC or customer acquisition cost is the money that you spend on acquiring a customer. When you launch your startup with a new product and unknown brand, your CAC may be high, but as you understand your ideal customer, find your best performing marketing channel, and gain referrals through your early adopters, your CAC can start declining. CAC includes your expenditure on sales, marketing, and distribution activities.
3. Churn Rate
Churn rate indicates the percentage of your paying customers that canceled their purchase. This is a metric that you should aim to keep as low as possible.
4. Customer Retention
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 you are delivering the promised value to your customers and they are happy with your product.
5. Cash Flow
Cash flow measures your costs versus revenue as it captures money going in and out of your business. Positive or free cash flow indicates liquidity with more money flowing into the business than out of it.
6. Return On Investment
ROI or return on investment is a metric for calculating the gains or losses derived from an investment. To calculate your return on investment in a new venture, project or initiative, divide your profits or losses by your total investment and multiply the result by 100 to get the ROI in percent.
7. Burn Rate
Burn rate means the amount of capital that a startup is spending or “burning” to finance operation. The burn rate of a startup can depend on the business model, funding and growth strategy.
Revenue is the money that you generate through sales and is a measure of startup performance. However, in many cases, revenue is not an accurate measure of your company’s financial health as it does not take into account business expenses.
9. Net Income
Your net income is the difference between your revenue and expenses. Paying close attention to your customer’s 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, thus run a profitable startup venture while understanding the key metrics that play a big role in boosting your company’s financial performance.
If you are starting a new venture and believe that it is still early to start thinking and projecting the metrics above, remember that you could build a product that your customers love and still fail. A startup cannot sustain value creation if its most basic and key metrics don’t add up. At every stage of your venture, as much as you are thinking about your product’s value proposition, think about the financial health of your startup.