Figures are the best at reflecting your company's growth, and the metrics you track are important not only because they show you are going forward or backward, but also because they help you make reality-anchored decisions. But how can you determine which metrics can guide you best? You can find that out in the following material, written by Marius Ursache, entrepreneur, mentor and consultant for startups.
A few days ago I celebrated 21 years since starting my first business. During all these years, I have built one of the most successful digital agencies in Romania, a non-profit organization, the first startup accelerator in Romania, a music festival and a few more startups (some failures and some still working). I helped found the MIT Bootcamps program. I have created startup frameworks taught at MIT and Harvard. I have worked with Techstars and Singularity University as an EIR (Entrepreneur in Residence) and coached hundreds of start-up founders.
For many, this looks like an incredible success. For me, it was (and still is) a tough journey, especially considering that I graduated a medical school, got an MA in theater, and have no formal education in management or business. I had to learn everything the hard way, failing spectacularly, so many times, and making mistakes that cost me more than any MBA at the world's top universities.
During the first ten years, most of the things I did in my company were based on intuition. Yes, we were getting some figures from our accountant and we knew how much we were supposed to bill our customers, but what we did not know was how to look at those figures properly. Why bother with all those Excel spreadsheets and other similar stuff, when there was so much work to do for our paying customers. And by analyzing the only indicator that we were actually monitoring, that is the money in our bank account, we were doing great.
Then recession hit. We started losing money, employees and customers. And before we knew it, we were on the verge of having to close the company. I am more than grateful to a few of my colleagues who were strong and helped me rebuild things from the ground up. And from that point onwards we changed many things, but one of our first steps was to have a management dashboard with the important figures. In the end, we managed to manage our company based on something more than our intuition.
I'll share with you some of the lessons I've learned since then and tell you how I've been doing things ever since.
*Disclaimer: there are many terms that are difficult to translate from English to Romanian, starting from the topic of the article, where I had to write about metrics and KPIs. To be able to understand one another better, in the Romanian interview I used ”indicatori” when referring to metrics, and ”indicatori-cheie de performanță” when referring to the key performance indicators.
Why is it important to track the metrics?
Is it because some management gurus say that "You can't manage what you can't measure"? No! Is it because all successful companies do it? No again! Is it because I’ve read that in an article written by Marius? Definitely not!
There are only two reasons for which we should track them:
To assess whether the past strategy was sound.
To make decisions.
For the first reason we will have to track the lagging metrics, such as revenues, expenses, profit, cash flow, average income per employee, etc. They look good (hopefully) in a quarter-end report, but are of little use for actually running the company. They can only tell you if what you did in the past was OK, but don’t give you any clue about the future.
For the second reason we will have to track the leading metrics, i.e. things that change from one day to another or from one week to another (such as website visitors, CPC campaign, customer acquisition/activation, referrals, etc.). They help you make decisions and you have to measure them over a much shorter period (i.e. weekly).
My suggestion is to ask yourself not only what information the metrics you choose to track will give you, but what decision they will help you make.
What is success?
For some entrepreneurs, the answer to this question is money, fame and prizes, for others it is to make the world a better place.
But, in business, success is most often defined as "shareholder added-value"—that is value brought to those who own the company. And, in most cases, this means the cash (liquidities) generated by the company. You can have prizes, a great team, an inspiring mission, but if you don't make money, the company dies.
But why are we talking about cash, and not profit or revenue? One of the first lessons in economics is to understand that Revenue is Vanity, Profit is Sanity and Cash is King. Thus, an entrepreneur's number one priority should be to avoid any situation which results in the company running out of cash.
Key. Performance. Indicators
Not all metrics measure performance. The average temperature in your office is a metric, but I doubt it is a performance indicator. Given that we said that "success = cash", performance should be defined as anything that increases your chances to ... generate cash.
Billables, number of customers, average collection period, receivables, operating expenses, customer acquisition cost are good examples of performance indicators. The number of employees, the number of prizes and the air temperature in the CEO's office are not (most often) performance indicators. they are just metrics.
Key means "important". We tend to forget this when we define 15 key performance indicators. We can't focus on 15 things at once, so that is why we have to follow the rule of three and choose three key performance indicators. "No more, no less" said Master Yoda in Star Wars.
So, what should I measure?
It depends on the type of company, but for the sake of simplicity, I will take as example a startup, where it’s not about tracking many metrics, but about tracking the right ones.
“Top level" indicators (or how we make money)
"Top level" means all company revenues, and these metrics analyze how you make money. I will list the indicators from lagging (long term) to leading (short term):
The Annual Recurring Revenue (aka ARR) is useful when comparing yourself to other similar companies at the same stage.
The Monthly Recurring Revenue (aka MRR) is common for subscription business models. My recommendation is to drill down and look at the new MRR, lost MRR, expansion MRR, contraction MRR - to fully understand the revenue dynamics.
Non-recurring monthly revenue (common for transactional and service business models).
The number of customers as an equation of the previous month, plus new customers minus lost customers.
The average revenue per customer helps you understand whether new customers are better than previous customers.
Gross Profit & Gross Margin help you understand how much money your company is actually left with after deducting the external costs for generating that revenue from the revenue in question (i.e. if you sell branded T-shirts for €50 but you buy them from China for €5, pay €10 per piece to print each T-shirt and €5 to ship it, your gross income is not €50 but €30). The gross margin helps you compare with similar companies.
Marketing and sales metrics (or how we bring in customers)
They are income precursors, so they are good predictors of the income to be generated. They vary a lot by business, but here's how you should measure them:
The marketing pipeline metrics help you understand how you 'acquire' people interested in your product or service - from reach (the number of people who hear about your company or see your ads), to engagement or traffic (how many people actually click on what they see about your company), to purchase (they contact you, which means they're interested - in startup terminology they're called marketing qualified leads or MQLs). Referrals and viral coefficient are also important if you have many clients who refer you to others.
Sales pipeline metrics help you understand how you're monetizing an MQL. They measure the qualification (how many MQLs actually have the need and budget to buy what you're offering), demos (which means customers invest valuable time), deals signed or lost, broken down by reasons for loss, which will help you decide which features to build or which different customers to target. For enterprise sales, I recommend tracking the bookings and average annual contract value, which shows progress. If the sales process is fully automated, then started and expired trials are a good way to understand the dynamics of the product value.
The Unit economics metric helps you understand if your marketing and sales processes are effective. You should therefore track the Customer Acquisition Cost (by dividing all marketing and sales employees’ salaries, plus all advertising costs, by the number of customers), the Customer Lifetime Value (by dividing the monthly gross profit by the number of customers of that month, then multiplying it by the lifetime in months; lifetime is calculated by dividing 1 by the monthly churn, i.e. the percentage of customers lost during that month). Your Customer Lifetime Value should normally be at least three times bigger than the Customer Acquisition Cost. You should also be able to recover your Customer Acquisition Cost in less than 12 months from your customer revenue (just divide the Customer Acquisition Cost by the Monthly Customer Value to find this number called the CAC payback period) .
Financial metrics: cash flow
The cash balance is 'duuuh', but it helps you decide whether to pay an invoice today or wait until the customer pays.
The cash flow from operations helps you understand how much money you are "bleeding" or "earning" every month. More simply put, you subtract all the money that leaves your bank accounts from the money coming into your bank accounts. Burn Rate is the name more commonly used in startups for this metric and is even more suggestive.
Runway is also a useful metric. It tells you how much time you have left (until you run out of money) so you can start fundraising at least a few months in advance.
Financial metrics: Profit & Loss
Revenue: this one is pretty suggestive, but depending on the business model, I recommend breaking down the revenue into recurring / non-recurring (see above) to better understand its dynamics.
Cost of goods sold: how much it costs to deliver the product to the customer (external costs, time). If you are a SaaS, this will include the hosting fee, card transaction fees and other fees for the cloud platforms you use. If you are an eCommerce start-up, this is the cost (not the price) of the product you receive from the supplier, shipping, card transaction fees. For a startup selling services, this includes business travels to customers, software licenses, photos or videos that are part of the project.
Gross Profit & Gross Margin (explained above)
• Research and development (salaries of the people building your product, cloud subscriptions for Jira or other software development tools).
• Marketing and sales (salaries for marketing and sales people, advertising costs, tools like Hubspot or Salesforce).
• General and administrative (management and administrator salaries, rent, utilities, legal and accounting services, bank fees, insurance, etc.).
EBITDA (a firm's earnings before interest, taxes, depreciation and amortization): tells you how profitable you are as a business (without taking into account long-term assets such as machinery, computers and equipment).
Net income: The golden standard, the Holy Grail, the Mother of all metrics. The bigger, the better, of course.
Financial metrics: Balance sheet
Accounts receivable: Money invoiced but not collected yet.
Debts: Money owed to your suppliers, to the government and to the banks.
This is a separate topic that deserves an article or even a whole book focused only on this. These are usually calculated by using two or three basic values and are very important for comparing yourself to other similar companies:
LTV:CAC ratio (divide LTV by CAC). This should be at least 3:1 for the business to be viable.
Revenue per employee.
Average revenue per customer.
And many others... these variate from company to company, business model to business model and according to the stage the company is in.
It's important to have the passion and guts to become an entrepreneur, but once you're in the game, metrics will help you understand how your business is performing and what decisions to make, decisions that are backed by real data, not just dreams.
If this is in sync with the way you see yourself and how you build your business, contact me. I am happy to help fellow founders because I know how long it took me to "get" this knowledge and how it has changed the way I do business ever since.
Best of luck to you!