Starting a business is already hard enough from an operational perspective, right?
Moving from having an idea to executing a project that lifts things off the ground is all-consuming, although rewarding over the long term.
The truth is that the operational and development sides of a business can take so much time out of the hands of its founder(s) that the financial side sometimes get neglected and can lead to serious consequences – especially if you find yourself out of cash at some point.
Business consultant Jasdeep Singh believes that if you are the founder of a startup and your strong suit is the operational or development side of the business, the key is to long-term viability is to keep an eye on certain critical metrics that will help you understand where the lifeblood of your company stands: cash flow.
Monitoring these variables regularly will help founders to determine if the business’ finances are healthy enough to keep things running smoothly, while also avoiding being overwhelmed by information that may cloud an analysis.
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1- Gross & Operating Profit Margins
Profit margins are percentage indicators that tell you how much money the company earns from each dollar it sells.
The gross profit margin indicates the percentage that the company retains after direct costs are deducted from revenues. Those costs can be broken down into three categories: direct materials, direct labor, and direct overhead.
Meanwhile, the operating profit margin allows founders to keep track of how much money the company retains once operating expenses like rent, utilities, salaries, and marketing expenses are deducted.
The higher these margins the better – especially the gross margin – as the company will have more money to utilize to increase R&D, marketing, hiring, or to pay off high-interest debt.
2- Revenue per Employee
The number of employees a startup hires is critical as every single person that joins the team should add value to the company.
Although employees should not be viewed as a commodity that can be priced, a basic ratio can be achieved by dividing the amount of revenue that the business generates by the number of employees that currently participate in the business. The purpose of this calculation to help leaders keep track of how the indicator has fluctuated over time to analyze if new hires have added value to the company – which usually translates into higher revenues over the long run.
3- Return on Marketing Investments
Marketing is what brings money home and is a crucial expense for virtually any startup. Marketing drives brand development as well as awareness, which are critical to acquiring new customers.
Marketing expenses can take a big chunk off the revenues that a startup generates and that is normal.
However, founders should keep an eye on the results of those marketing efforts by tracking indicators like the Return on Ads Spend (ROAS) or the Cost per Lead (CPL), depending on the type of business.
These indicators will show if advertising money is being used efficiently to drive more sales, which should help founders to make efficient decisions about next marketing steps.
4- Cash Burn Rates
Businesses do not go bankrupt because they don’t sell. Businesses go bust because they run out of cash.
With that in mind, cash flows are an essential piece of the puzzle for any company and founders must keep track of how much cash the business has and how long it will last before another round of funding is needed.
In this regard, Dr. Singh, who is an MBA-candidate from the University of Connecticut and advises businesses in that same state, says founders must learn to differentiate between the gross cash burn and the net cash burn rate, as they both tell different stories.
A gross cash burn shows how much cash the company is spending every week or month while the net cash burn shows how much cash the company is losing after deducting cash inflows from the total outflows.
By knowing the net cash burn, founders can quickly assess how many months of expenses they can currently cover with the business’ cash reserves to prepare adequately if some extra funding is needed to keep things running.
Although keeping track of the financial side of a startup sounds time-consuming and daunting, finances are key to building a stable company. While some financial activities, such as bookkeeping, can be delegated, decisions about how to acquire and utilize cash must be central to any business plan. There are many online systems to help track these metrics but learning what they mean and how they may inform your decision making are key.
Companies that thrive need more than just great products, they need smart money management and financially-sound decision making. Getting the financial analysis process to be as simple yet holistic as possible is an important step.