The path to success for startups and small to medium-sized businesses is paved with some hard business lessons along the way. However, entrepreneurs can circumvent early missteps by familiarizing themselves with certain key business metrics. These numbers can help founders better understand the overall health of their businesses and illuminate where adjustments or further investments should be made within their operations.
1. Customer Acquisition Cost (CAC)
Your customer acquisition cost (CAC) measures how much your business is spending to acquire every new customer you receive. Elements such as total marketing and sales costs factor into this number —the lower the resulting number, the more sustainable your costs have become. CAC can be calculated by taking the sum of your total sales and marketing spend in a given period and dividing it by the number of new customers you’ve acquired over that same period.
A low CAC often means business owners are seeing a high return on their investments in sales and marketing efforts such as advertising campaigns, event attendances, and CRM costs, or even illuminate the efficacy of a sales team. However, as with any key business metric, your CAC may shift as your business scales and grows. Startups and SMBs earlier in their journey, for example, may report a high CAC as they test different marketing and sales strategies that will help them enter the market.
2. Churn / Attrition Rate
Your customer churn rate (also known as attrition rate) is a measure of how many customers have ceased doing business with your company over a certain period of time. For SaaS or other subscription-based businesses, this means customers are not renewing their services on your platform. For more traditional brick-and-mortar businesses, this often means customers are not returning to your business or are turning to competitors instead.
Monthly churn can be calculated by dividing the number of customers lost in a certain month by the total number of customers reported at the beginning of the month. It is often useful for entrepreneurs to speak to customers or collect feedback at the time that these customers leave to better understand why they’ve ended their services. A high churn rate can be indicative of larger product, service, or communication issues that are hindering customers’ experiences with your business.
3. Monthly Recurring Revenue (MRR)
Monthly Recurring Revenue (MRR) is a projection metric that represents how much revenue your business should expect to generate each month. This metric is key to overall planning since business owners will need MRR to calculate how much they should budget for certain activities over a given period. MRR is often a bit easier to anticipate for subscription-based businesses, but even non-subscription-based businesses can look at recurring monthly or yearly customer contracts to measure MRR.
MRR can be calculated in many different ways depending on the complexity of your business. One of the more basic ways to project your MRR is to look at the average of your last six months of revenue, assuming that your core business activities will stay the same. Your MRR should stay fairly consistent, barring any large disruptions to your business, the economy, or anything else that may cause a high customer churn.
4. Rule of 40
Many investors will use the Rule of 40 to compare businesses. Rule of 40 is calculated as your annual revenue growth rate, plus your profit margin.
For instance, if your business is growing at 30% annually, and you are generating a moderate profit of 10%, your business is 40 on the Rule of 40 measure, and investors view this positively. Similarly if your business is small and in hyper-growth mode, growing at 150% annually, and you are losing 50% profit margin, your business is 100 on the Rule of 40 measure, and still viewed positively. As companies reach a higher scale, their growth may slow, but they should be building profitability at the same time. The Rule of 40 metric provides a balance between revenue growth and profitability.
5. Cash Runway
Cash runway determines how long your business can go on operating before it runs out of money, assuming no other funds or revenue sources are raised. Cash runway goes hand-in-hand with a company’s burn rate (the rate at which your business is spending money), and helps business owners better plan and strategize with the funds they have available to them today.
In order to calculate cash runway, you’ll need two numbers: your cash balance and your monthly expenses. Your cash balance is the amount of cash your business has on hand. This is typically money saved or reserved specifically for unplanned or atypical expenses. Your monthly expenses are the sum of all your business costs during an average month. By dividing your cash balance by your monthly rate, you can calculate how many months of a “cash runway” your business has before you’ll need to find alternate sources of funding or cease operations.
Armed with these key metrics, business owners should have a better idea of where to focus their efforts and what signs they should keep an eye out for as they run their business. While these metrics only scratch the surface of how entrepreneurs can make sense of their balance sheet, a foundational familiarity with these five metrics will help them go far.
Megan Wood is the Chief Strategy Officer at DigitalOcean.