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Here's what accountants need to know about advising startups

Photo: Oli Scarff/Getty Images.

Startups are sexy, and everyone’s uncle is working on the next big calendar app (no jokes, I did get pitched another calendar app last week).

As a result, professional service providers are now offering “startup” packages or services to try to capture a chunk of this growing market. Some do it well and have an understanding that a high-growth tech company has different fundamentals to your local café, others simply add new section to their website, and voila! They’re “startup accountants”.

As you know, the use of metrics is vital for understanding, measuring and improving your business.  Accountants can play a key role in helping business owners set and monitor these metrics, but the challenge is understanding the plethora of metrics that are suitable and appropriate for each kind of business.

The challenge for accountants and business advisors is keeping up to date with evolving business models and understanding the drivers of modern age tech companies and what metrics they should be monitoring.  For an early-stage startup, EBITDA is just not going to cut it.

If you throw out terms like CLV, MRR, CAC and Churn to accountants, most of them will be left scratching their heads wondering if you are speaking finance, English or PHP.

Scalable startups are a completely different and unique business model compared to small businesses. Whilst the term “startup” is subjective, for the purposes of this article assume we are talking about a high-growth technology company with global potential.

We’ve included a summary of the key metrics that accountants should be monitoring when advising startups.  These only scratch the surface, but it’s a start:

Financial Metrics

MRR – Monthly Recurring Revenue

The amount of recurring revenue normalised into a monthly figure. Arguably the most important software-as-a-service (SaaS) metric.  Recurring revenue is king for startups, and business in general. Therefore monitoring this metric on a monthly basis is critical. Be sure to separate recurring revenue from “once-off” charges like installation or setup costs.  It’s also important to note that MRR is not the same figure as your accounting revenue for the month.

ARR – Annualised run rate

Your MRR x12.  Your annual recurring revenue for the forward looking 12 months.

LTV – Lifetime Value

Lifetime value is the present value of the future profit from the customer over the duration of the relationship. It helps determine the long-term value of the customer and how much net value you generate per customer after accounting for customer acquisition costs (CAC). You can calculate LTV using this approach

CAC – Customer Acquisition Costs

Customer acquisition cost or CAC should be the full cost of acquiring users, stated on a per user basis.  This can be calculated fairly simply by taking all sales and marketing costs for a period divided be the number of customers acquired.

There a few traps that businesses make when measuring CAC. These include:

  1. Failing to include all the costs incurred in user acquisition such as referral fees, credits or discounts;
  2. Calculating CAC as a “blended” cost (mixing acquired users acquired organically) rather than isolating users acquired through paid marketing.

LTV/CAC Ratio

Most tech startups (there are exceptions) who sell directly to their customers — both enterprises and consumers — must eventually become profitable.  In the early stages profit is sacrificed for growth.  So how do you tell your business model is fundamentally sustainable?  The LTV/CAC ratio.  Rule of thumb is that your unit economics are sound if your ratio is >3. There’s a lot of reasons as to why (a discussion that is better suited for separate blog post), but it is suffice to say that the LTV/CAC ratio speaks to a startup’s revenue trajectory and capital needs. The lower the LTV/CAC ratio, the less efficient a company is at deploying capital and the more money it needs to fuel growth. Conversely, the higher the LTV/CAC ratio, the more efficient the company is and thus the more value it creates for the same amount of capital.

Burn rate

Burn rate is the rate at which cash is decreasing. Especially in early stage startups, it’s important to know how much cash you are spending a month and how many months cash you have left in the bank. Many companies fail when they are running out of cash faster than they are bringing revenue in and don’t have enough time left to raise funds or reduce expenses. Cash flow forecasts are therefore critical and you are best placed to assist these companies to develop those!

Product and Engagement Metrics

MAU – Monthly Active Users

The number of users the company has which engage or are “active” within the month.  Measures the usage of the product. Different companies have different definitions of what ‘active’ means, so ensure this is clarified at the beginning.

MoM – Month-on-Month growth

The percentage rate at which something, usually revenue or users is growing on a monthly compounded basis. Also known as Compound Monthly Growth Rate (CMGR).

Churn rate

Customer or user attrition for a given period expressed as a percentage.  Initially used for subscription businesses but now a popular metric for non-subscription businesses such as eCommerce.  In such cases, it’s important you define what constitutes a “churned” customer.

The above list isn’t comprehensive, but if you’re an accountant who has startup clients and hadn’t heard of these, you better catch up.  As business models evolve, business advisors must also evolve and adapt to be best placed to consult and advise their clients.

This post originally appeared on LinkedIn. You can read the original article here.

Rowan is a Chartered Accountant and Co-founder of SmartBooks Online – a virtual bookkeeping practice designed to free SMBs and accountants from administration and data entry.

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