Jeff Jordan, Anu Hariharan, Frank Chen, and Preethi Kasireddy consider themselves very lucky to have an opportunity to meet thousands of entrepreneurs every year. Thus, they see various metrics that display health of companies. But there are cases when metrics don’t really display the state of business or people use various interpretations of one and the same metric.
So, the authors have compiled a list of common metrics and the ones that are easy to confuse. It’s true that “good metrics aren’t about raising money from VCs — they’re about running the business in a way where founders know how and why certain things are working (or not) … and can address or adjust accordingly.”
Bookings and revenue are different things, so don’t interchange them.
Bookings are the value of a contract between the company and the customer. It’s a contractual obligation on the part of the customer to pay the company.
Revenue is recognized when the service is actually provided or over the life of the subscription agreement.
Pay attention to the fact that letters of intent and verbal agreements are neither revenue nor bookings.
Investors tend to value higher the companies which get the majority of total revenue from product revenue. It happens so because a) revenue isn’t recurring, b) has lower margins, c) less scalable.
Product revenue is the what you generate from the sale of the software or product itself.
ARR (annual recurring revenue) is a measure of revenue components that are recurring in nature. It doesn’t include non-recurring fees and professional service fees.
ARR per customer: Flat or growing? If you upselL or cross-sell your customers, it should grow (it’s a positive sign for a healthy business).
MRR (monthly recurring revenue): Multiply one month’s all-in bookings by 12 to get to ARR. Some widespread mistakes: a) to count non-recurring fees (hardware, setup, installation, professional services / consulting agreements), b) to count bookings.
Gross profit allows to understand how profitable the revenue stream is.
It depends on a company, but usually costs concerning manufacturing, delivery, support of a product/service are included.
Don’t forget to break down what is included in / excluded from that figure.
TCV (total contract value) is the total value of the contract, and can be shorter or longer in duration. It should also have the value from one-time charges, professional service fees, and recurring charges.
ACV (annual contract value) is the value of the contract over a 12-month period.
What more you can learn about ACV:
What is the size? (Are you getting a few hundred dollars per month from your customers, or are you able to close large deals?)
Is it growing / not shrinking? Customers are paying you more on average for your product over time if it’s growing. It means that your product does more to warrant the increase or delivers much value and customers want to pay more for it.
Lifetime value is the present value of the future net profit from the customer over the duration of the relationship. It’s necessary to understand a customer’s long-term value and what amount of net value you generate per customer after accounting for CAC (customer acquisition costs).
A mistake that occurs quite often is that the LTV is estimated as a present value of revenue or a gross margin of the customer. It should be calculated as net profit of the customer over the life of the relationships.
The authors offer a way to calculate LTV:
Revenue per customer (per month) = average order value × the number of orders.
Contribution margin per customer (per month) = revenue from customer – variable costs associated with a customer. Variable costs means selling, administrative and any operational costs associated with serving the customer.
Avg. life span of a customer (in months) = 1 / by your monthly churn.
LTV = Contribution margin from customer × the average lifespan of a customer.
If there are only several months of data available, look at historical value to date in order to measure LTV. It’s better to measure 12 month and 24 month LTV, rather than predict an average life span and estimate possible retention curves.
LTV as it contributes to margin is another essential calculation because gross margin LTV or a revenue means a higher upper limit on how much you can spend on client acquisition. Contribution Margin LTV to CAC ratio also allows to define CAC payback and adjust spendings on advertising and marketing.
It’s a widespread situation when people interchange the two metrics, but they aren’t equal.
Gross merchandise volume (GMV) is the total dollar amount of merchandise transacting the marketplace during a definite period of time. It helps to find out the real line what customers spend and measures the marketplace size.
Revenue is a part of GMV that marketplace “takes”. There are many components (fees) to revenue, for example, transaction fees based on GMV successfully transacted on the marketplace. But there also can be fees that are a fraction of GMV: sponsorship, ad revenue, and so on.
The authors of the article say that “this is the cash you collect at the time of the booking in advance of when the revenues will actually be realized.”
And as they told about it some time ago “SaaS companies only get to recognize revenue over the term of the deal as the service is delivered — even if a customer signs a huge up-front deal.” Thus, in a great many of cases “booking” is included to the balance sheet in a liability line item (deferred revenue). As they explain further “As the company starts to recognize revenue from the software as service, it reduces its deferred revenue balance and increases revenue: for a 24-month deal, as each month goes by deferred revenue drops by 1/24th and revenue increases by 1/24th.”
Looking at billings (take the revenue in ¼ and add the change in deferred revenue from the prior quarter to the current one) is the right way to measure growth and health of a SaaS company. Billings increase, if a SaaS company grows booking.
Pay attention to such a forward-looking of a SaaS company health as billings (rather than revenue as it underrates the true client value and it’s recognized ratably. Moreover, a SaaS company can have stable revenue for a long period of time — just by working off its billings backlog — which only suggests a healthy state while in reality it may not be like that).
Customer acquisition cost (CAC) is the full cost of user acquisition, stated on a per user basis. But, in reality, there are many variants to it.
The most widespread problem is that it doesn’t include all costs implied (credits, referral fees, discounts). One more problem is calculating CAC as a “blended” cost where organically acquired users are included instead of separating them from the “paid” ones. Blended CAC (total acquisition cost / total new customers acquired across all channels) isn’t wrong but it doesn’t provide the information on the efficiency and profitability of your paid campaigns.
It’s a reason why investors think that paid CAC (total acquisition cost/ new customers acquired through paid marketing) is more essential the blended one for evaluation business viability. It gives the necessary information for deciding whether a company is ready to scale up a user acquisition budget profitability.
There are many investors who prefer to see both. But they do like the blended number and CAC to be broken out by paid and unpaid. It’s also useful to see the breakdown by dollars of paid customer acquisition channels.
It’s very important to realize that costs grow as you try to reach a larger audience. For example, it costs $1 to get first 1,000 users and $2 for 10,000 and so on. That’s why you shouldn’t neglect metrics concerning the amount of users acquired via each of channels.
It turns out that various companies have their own definitions for an “active user”. Define clearly for what an “active user” means.
Most of the time, it’s a simple average of monthly growth rate. However, some investors measure it as CMGR (Compounded Monthly Growth Rate) as it measures the periodic growths, for a marketplace especially.
CMGR (CMGR = (Latest Month/ First Month)^(1/# of Months) -1) is useful for benchmarking growth rates with other companies. The authors claim that “This would otherwise be difficult to compare due to volatility and other factors. The CMGR will be smaller than the simple average in a growing business.”
There are many types of churn (customer, dollar, net dollar) and there are many variations of how it can be measured. Some prefer to measure it on a revenue basis annually (it mixes upsells and churn).
That’s the way investors see it:
Monthly unit churn = lost customers/prior month total
Retention by cohort
Month 1 = 100% of installed base
Latest Month = % of original installed base that are still transacting
Pay attention to the fact that it’s essential to differentiate between gross churn and net revenue churn —
Gross churn: MRR lost in a given month/MRR at the beginning of the month.
Net churn: (MRR lost minus MRR from upsells) in a given month/MRR at the beginning of the month.
There’s a huge difference between the two. Gross churn is the actual loss to the business. Net revenue churn underrated losses because it mixes absolute churn and upsells.
It’s the rate at which cash is decreasing. It’s very important to know and monitor this rate (especially on early stage of a startup) in order not to fail when a company runs out of cash and don’t have time to get money or lower expenses.
Here’s a calculation for you:
Monthly cash burn = cash balance at the beginning of the year minus cash balance end of the year / 12
Net burn vs. gross burn:
Net burn (revenues (including all incoming cash you have a high probability of receiving) – gross burn) is the real measure of how much cash a company burns every month.
Gross burn is monthly expenses + any other cash outlays.
There’s a tendency to concentrate on net burn in order to understand how long the money you have (in a bank) will last for keeping a company running. The rate at which revenues and expenses grow may also be taken into account as monthly burn may not be a constant number.
Downloads are number of apps delivered by distribution deals. In reality, it’s just a metric of vanity.
Investors want to see engagement expressed as cohort retention on metrics essential for business (DAU, MAU, photos viewed/shared, etc.)
For a business that has some kind of activity cumulative charts always go up to the right. Although, they are an invalid growth measure as they can go up to the right when a business is shrinking.
Investors prefer to see monthly GMV, monthly revenue, or new users/customers per month in order to evaluate the growth.
There is a great many of such tricks. But some common ones are about not labeling the Y-axis, shrinking scale to exaggerate growth and presenting percentage gains without showing absolute numbers. The last one is misleading, according to the authors of the article, as percentages may seem impressive off a small base but they don’t indicate the future trajectory.
As you tell your story, you can present metrics in any order you want.
During an initial evaluation of a business, investors tend to look at GMV, revenue, and bookings first as they indicate the business size. Then they want to look at growth in order to see the performance of the company.
It’s like a baby health check: weight, height and comparison to the previous results in order to make sure that things are OK and you can go deeper.