Startup founders have a million things on their minds: building a product, hiring a team, raising capital, getting that early traction, figuring out how to scale, or frantically throwing water on whatever metaphorical fires are inevitably burning.
Compared to those things that are clearly existential in importance — failure on any one can be the end of your company — keeping accurate books can seem a bit mundane, and something that a founder can outsource and call it good. The reality is, the appropriate setup and accuracy of your books and having a close eye on what they’re telling you is, more often than not, a foundational step that can make your startup wildly successful.
Here's how to make sure you're at the top of your game.
Start by Digging into Your Most Critical Growth Metrics
If you’ve raised money, you’ve probably done a lot of talking about and a lot of analysis on metrics like customer lifetime value (LTV) and customer acquisition cost (CAC). For many startups, especially in tech, these metrics form your “unit economics” and essentially dictate if you’re ready to step on the gas and scale with additional capital.
If you’re earlier in your journey, you’ll want to get intimately familiar with LTV and CAC.
The basic idea is this: the value of a customer to your business, over their lifetime with you, must be greater (usually significantly greater) than it cost you to acquire that customer.
As a simple example, if an average customer is worth $1,000 to your business while they're your customer, you won’t want to spend $2,000 acquiring that them (through marketing and sales costs, etc.)
The old dot-com cliché, “We lose money on every customer, but we make up for it in volume,” reflected a popular strategy at the time. Of course, that strategy isn't right for every business — here’s looking at you, MoviePass! If you want to scale your startup you need, at the very least, a positive LTV to CAC ratio.
Focus On Improving Your Unit Economics
We won’t go into the specifics of what “good” unit economics look like here, though many investors place the minimum acceptable value for the LTV to CAC ratio at 3:1, and some argue that it needs to be much higher.
You can improve this ratio by decreasing acquisition costs (through more efficient sales channels) or increasing lifetime value (through more effective pricing, a stickier product, etc.)
The problem is many startup founders drastically overestimate their LTV to CAC ratio.
The first way to they do this is by using revenue instead of gross profit when calculating customer lifetime value.
As an example, a SaaS startup may have a 3% monthly customer churn rate (the percentage of customers you lose in a given month and the inverse of customer retention) and a product that’s priced at $90/month. Many founders calculate LTV simply by dividing revenue by churn rate: in this case, $90/.03 = $3,000.00.
Let’s say — and we’ll explore this more in a moment — that this founder believes they can acquire customers for $1,000. That would give a 3:1 ratio. Looking pretty good, right?
What the founder neglected to count was a bookkeeping fundamental: the concept of gross profit.
Understanding Your Startup's Gross Profit
Gross profit is the value that remains when you take your revenue and subtract away all the direct costs that are necessarily incurred by delivering your product or service. In our hypothetical SaaS company, this probably includes at least server and storage costs, customer success, any third-party software used to deliver its own software.
Often, these costs will eat up 20-30% of your revenue (said another way, leaving you with a 70-80% gross margin). Meaning, our example customer wasn’t actually worth $3,000 — instead, they were actually worth something like between $2,100 and $2,400.
Only a closely tracked and accurate of set of books will give you your gross profit accurately. Every time a cost is incurred that is directly related to delivery of your product or service, that needs to be categorized somewhere in your cost of goods or cost of services categories.
By doing this, you'll be able to see at a glance exactly what your gross profit is — and that’s the real metric you should use — not revenue — when you’re calculating LTV.
Now let’s look at the customer acquisition cost side of the equation.
Understanding Customer Acquisition Cost (CAC)
Conversely, it can be easy to underestimate your CAC without a close and careful look at an accurate and well-kept set of books.
A simple way to calculate CAC is to take everything you spent on customer acquisition over some period and divide it by the number of new customers gained over that period.
For example, if our SaaS company spent $500,000 one year on customer acquisition, and gained 500 new customers, then its CAC was $500,000 / 500, or $1,000.
Let's dig deeper, though. Our SaaS founder may have done a quick-and-dirty estimation to get to that $500,000, simply adding up their company’s advertising costs, wages of sales and marketing employees and contractors.
In reality, that’s probably not enough. What about the meals and entertainment expenses that weren’t just for company outings, but were for taking potential customers out for pitch meetings? What about the travel expenses the VP of sales incurred to get to that meeting?
Solid bookkeeping won’t group those “Meals and Entertainment” and “Travel” expenses all together — rather, they’ll be tracked separately for those that are related to customer acquisition (like traveling to the meeting) and those that aren’t (like traveling to a board meeting).
How to Ensure Your Startup's Accounting is Accurate
One way to do this is to create multiple categories that serve those different purposes.
For example, you could have “Travel – General” and “Travel – Customers.” When it comes time to calculate your CAC, filter and add up all of the expense categories that you’ve set up specifically for customer acquisition. With just a few clicks in Quickbooks (or an alternative), you’ll have an accurate-to-the-penny CAC value.
Back to our hypothetical SaaS startup. Let’s say that after including those expenses for the year, the company actually spent $600,000, not $500,000, on customer acquisition. That means, after we divide the new value by our 500 customers gained, our CAC increases from $1,000 to $1,200.
Unfortunately, the number of new customers didn’t increase along with our improved accounting of acquisition expenses!
Let’s put this all together and look at why accurate bookkeeping is so important for startups.
Why Accurate Bookkeeping Matters for Startups
Look at what happened to our unit economics when we adjusted our numbers.
With our original, overestimated LTV and underestimated CAC, we came out with a LTV ($3,000) to CAC ($1,000) ratio of 3:1, which had us feeling pretty good. We had a good indicator that we might be ready to raise capital and really start scaling.
With our new, accurate LTV and CAC (let’s use the more optimistic LTV and we’ll have $2,400 and $1,200, respectively) we come out with something very different: a ratio of 2:1.
At 2:1 as opposed to 3:1, this is a really different business.
You’ll have a harder time raising money, a harder time scaling, and your business won't look very interesting to potential acquirers.
You may be thinking you don’t like the new definition very much — might as well stick to the old one! After all, investors are going to be much more excited about 3:1, and you’ll figure it out as you go after raising that Series A.
But using lazy definitions doesn't produce the benefits of accurate bookkeeping, and it isn’t just worrisome for investors — it’s really problematic for the startups that do this. After all, the narrative you tell often is the one you’ll start to believe!
The 3:1 ratio will influence your financial projections, which in turn will set the expectations you have of yourself and that your board has of you. When the success foretold by that fictious ratio doesn’t come to pass, you’ll find yourself in an uncomfortable position with disappointed and agitated investors, your cash burning up faster than you expected, and a team that’s getting nervous things aren’t going as planned.
Disciplined Bookkeeping Reveals Your True Unit Economics
When you deploy a disciplined bookkeeping practice to get to the reality of your unit economics, you’ll make far better business decisions.
If your ratio is 2:1, and it needs to be 3:1, then you’ll focus on actually increasing customer lifetime value or actually decreasing acquisition costs through operational improvements or innovations. And then, when you get where you need to be, you’ll be ready to raise that money, build out your sales team, and finally scale up — whatever your goal is — and you can be confident that your business is ready for it!
Stay on Top of Your Books
Bookkeeping may seem passé or a necessity to simply outsource and forget about, but that’s far from the truth. Bookkeeping is more essential than ever for tech startups whose trajectories and successes are determined by very specific metrics and milestones that signal actions to take with the business.
Stay on top of your books — not just in timeliness, but in specificity and accuracy — and you’ll see long-term rewards.
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