Startup founders have a million things on their minds: building a product, hiring a team, raising money, 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. But the reality is that the appropriate setup and accuracy of your books, and a close eye on what they’re telling you — can play just as important a role in making or breaking your business.
Even for startups.
Gauge Your Startup Metrics
If you’ve raised money, you’ve probably done a lot of talking about and a lot of analysis on metrics like 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 familiar with this concept. The basic idea is this: the value of a customer to your business, over its 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 over time, you won’t want to spend $2,000 acquiring that customer (through marketing and sales costs, etc.). This would be an example of the old dot-com era joke “we lose money on every customer but we make up for it in volume.” (Here’s looking at you, MoviePass!) In order to have a scalable business, you need, at the very least, a positive LTV to CAC ratio.
How to Improve 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.)
Many startup founders, though, drastically overestimate their LTV to CAC ratio.
The first way to they do this is by using revenue instead of gross profit when calculating lifetime value.
As an example, a SaaS startup may have a 3% monthly churn rate (the percentage of customers you lose in a given month — inverse of retention) and a product that’s priced at $90/month. Many founders would 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?
Well, no. What the founder neglected to count was a bookkeeping fundamental: the concept of gross profit.
What is 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. You’ll then be able to see, at a glance, exactly what your gross profit is — and that’s the real value — not revenue — that should be used when you’re calculating LTV.
Now let’s look at the customer acquisition cost side of the equation.
A Look at 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 formulate CAC is to take everything you spent on customer acquisition over some period, and divide it by the number of