if you are at the point where you are looking for investment, you should be all over your numbers; forecasts, margins and cash requirements.
the typical investor will be focused on the scalability of your business and the potential market size. however, they will also be very interested in how much it costs to bring customers to your business in that market (or an expanding demographic) and how much you expect to make from those customers. clearly the business model, founding team and market size are fundamental to exciting potential investors, but being on top of relevant metrics will totally differentiate you from other businesses competing for investor attention and funds!
investors find that the most successful founders tend to be those that have an obsessive focus on their kpis and the drive to constantly experiment and optimise them. excite the next founders you sit in front of by being all over the following:
- CAC (customer acquisition costs)
- LTV (lifetime value of a customer)
- LTV:CAC (ratio of LTV to CAC)
- CAC recovery time
- FCB (forecasted cash burn) or runway
- MAU (monthly active users)
- CRR (customer retention rate)
these metrics tell any investor (and even more importantly those managing the business) if there is a foreseeable future for the business. we always hear ‘cash is king’, and it most certainly is…until a point! if a company is to have any sort of lifespan other than just consuming cash, in the long term the business needs to make more money with each customer than it costs to find them and encourage them to buy. the greater the favourable gap LTV has over the CAC or the ratio of CAC to LTV, the better the business model looks. I say in the long term because to begin with, not all businesses that are on an aggressive customer acquisition journey will have a favourable LTV to CAC surplus.
if a business has some form of history, then internal data is the best way to calculate CAC and LTV. some businesses, particularly early stage ones, may struggle when calculating LTV, as the full life cycle of a customer may not have been realised i.e. you may find customers stay with your business for a 24 month period but you’re only 12 months into exploring this. in this case assumptions need to be made, either from external data or derived internally i.e. competitors or market data.
so, how do you calculate each of these and what do they really mean?
customer acquisition cost (CAC)
customer acquisition cost (CAC) is the cost to acquire a transacting customer. a transacting customer has exchanged either cash, vouchers, gift cards or a combination of these for the product or service.
CAC = total cost of bringing a new customer on-board / no. of transacting customers
if we spent a total of £5,000 and gained 420 transacting customers. CAC = £5,000 / 420 = £11.90
these types of customer on-boarding costs will vary depending on business and sector. however, most businesses focus on focused advertising as they key component of bring a new customer on-board and some typical channels include facebook adverts, referral marketing, twitter adverts, physical mailshots, tv, adwords, instagram adverts and cold calling etc.
an investor (and a half decent management team) should be interested in diving deeper into this and calculating the CAC by channel. this more insightful piece of management information can be tracked, reported on and used to continually lower the cost of acquisition. let’s take the example of using facebook and twitter as different channels to acquire customers (the same could apply for different campaigns within a specific channel such as facebook).
we spent £2,500 with facebook and had 350 transacting customers. CAC (FB) = £2,500 / 350 = £7.14
we spent £2,500 with twitter and had 70 transacting customers. CAC (Tw) = £2,500 / 70 = £35.71
straight away, you can see the £11.90 we calculated across all channels above is hiding an underperforming channel giving a CAC of £35.71. this could be due to customers not using this channel or the ad format or competitors on that platform. either way, we could significantly drive a lower CAC by focusing on the optimum channel to acquire customers.
lifetime value of a customer (LTV)
lifetime value of a customer (LTV) is the gross margin made before they stop using your service or buying any products.
in my opinion, businesses that sell a product should really only be interested in the gross margin when calculating the value of a particular customer group. in some businesses revenue appears to be the driver to calculate the LTV. however, this is only because there are no direct costs relating to servicing that specific customer group i.e. in a SaaS (software as a service) based model. in these businesses, revenue actually equates to gross margin because there are no direct costs (or they don’t scale to the same extent). I would remove any voucher you have provided them as an incentive to buy, which is often the case i.e. margin = revenue – less direct costs – voucher
LTV = year 1 gross margin + ((year 2 gross margin x (1 – attrition rate)) + … + (year n gross margin x (1 – year n attrition rate))
n = number of years you expect them to be customers.
product typically has a two year span with a customer
- £25 voucher given to new customer
- average annual product sale is £50
- 25% of customers lost after year 1 (or 75% of customers repeat buy in year 2)
- customers not tracked beyond year 2
- 60% gross margin (i.e. our product costs us £20)
LTV = ((£50 – £20) – £25 voucher)) + ((£50 – £20) x (1 – 0.25)) = (5.00+ 22.50) = £27.50
now you have both of these metrics, you can calculate the difference. LTV needs to be greater than CAC otherwise in the long term as, all things being equal, the business has no future in my opinion. the greater the difference means the more money you can make out of acquiring a customer relative to the cost of finding that customer.
using our facebook example above, we can see LTV – CAC (FB) = £27.50 – £7.14 = £20.36
it’s even more interesting to delve deeper into the LTV by channel. your facebook customers may have different characteristics than other channels i.e. lower attrition rate. this would then prove a more analytical tool to truly understand which channel to market within.
ratio of LTV to CAC (LTV:CAC)
the ratio of customer acquisition cost (CAC) to lifetime value of a customer (LTV) measures a crucial relationship between the cost of acquiring a customer and the total lifetime value expected from that customer.
LTV:CAC = lifetime value of a customer / customer acquisition cost
using data from previous examples
- LTV = £27.50
- CAC = £11.90
LTV:CAC = (£27.50 / £11.90) = 2.31 = 2.3 or 2.3:1
what does this mean? well, quite simply for every £1 you spend on acquiring a customer, you should make back £2.30 (or 2.3 times). however, beware that this excludes general overheads. if you are at 1:1 then clearly you are not making any money on the customers you are bring in i.e. for your cost of acquiring a customer, you are only earning the same back. if your ratio is too high it can indicate you are under investing in your marketing strategies and could be growing faster.
CAC recovery time
CAC recovery time or months to recover CAC is a the period of time to recover the amount of money invested in acquiring a new customer. it will tell you the break even point on your customers in general or a segmentation of your customers.
months to recover CAC = CAC / gross margin
using data from previous examples
- CAC = £11.90
- monthly gross margin = £30 / 12 months = £2.50 per month (annual sales price of £50 and gross margin of 60%)
months to recover CAC = (£11.90 / £2.50) = 4.76 = 4 months and 23 days
so after acquiring a customer at on average £11.90, it takes us 4 months and 23 days to recover that initial outlay. again, we could segment this by channel to delve deeper and understand our CAC recovery time by different channel which would have variables for both customer acquisition costs and lifetime value of customers.
forecasted cash burn (FCB) or runway
forecasted cash burn (FCB) is the amount of cash which is expected to be spent on a monthly basis (especially important for startups).
there is a big difference between costs incurred and cash spent, which why being on top of your working capital and leveraging payment terms from suppliers is absolutely fundamental. in a startup or scaling business cash spent month on month can vary tremendously and it usually increases month on month and new team members join and marketing costs continue to increase as expansion sets in. forecasts are fundamental but in absence of an up to date forecast I would recommend looking at the average of the last 2 or 3 months of cash spent and apply any factors you know are going to impact this such as new team members joining.
FCB = total cash expenditure in future months, month by month
another related useful metric is cash zero date which is the date at which you expect (based on forecasted cash burn), you will run out of cash. in other words how long you can continue in business before you need a further injection of cash.
cash zero date = cash balance/forecast monthly cash burn
- cash balance as at 31 January is £700k
- forecast monthly cash burn is £180k per month
cash zero date = £700k/£180k = 3.89 months = 3 months 24* days
*assuming 30 day month
so on the current rate of cash burn, you would have just under 4 months remaining until you run out of cash. this is also sometimes referred to as runway.
monthly active users (MAU)
monthly active users (MAU) is the total number of monthly users actually using your service.
MAU = total number of unique active users per month
- total number user accounts at the end of month is 21,523
- total number of logins in month 5 is 36,785
- total number of unique logins with activity 12,476
MAU for month 5 = 12,476
investors will only be interested in those unique active users, so don’t muddy the waters with users that are not actually using your service or total logins for the period, they will catch you out!
customer retention rate (CRR)
customer retention rate (CAC) is the percentage of customers you keep relative to the number you had at the start of your period. it does not include new customers for the month. it is the inverse of customer churn.
CRR = (total number of customers at the end of the month – new customers in month) / total number of customers at the beginning of the month
- total customers at the end of the month was 5 9,487
- new customers in the month 5 was 276
- total number of customers at the beginning of the month 5 was 9,496
CRR = (9,487 – 276) / 9,496 = 9,211 / 9,496 = 97.0%
the customer retention rate for month 5 was 97.0%. ideally you want this to be as high as possible, but in reality that will never happen. if you start to break down CRR by different segments you can start to identify if there are particular retention or satisfaction issues by customer segment.
the most important thing with these metrics and management information is that it gives you the insight to continuously tweak and improve the strategy of acquiring customers and understanding how much you are spending versus when you need funding. taking the time to investigate the data behind these metrics, and use what the numbers are telling you to adjust your strategy can mean getting the right investor at the right terms and at a time when your business is looking its strongest.
thanks for reading – if you have any comments or questions on the above, or are interested in talking to us, please get in touch.