Key financial metrics for growing businesses
Successfully growing a business requires knowing what's working, what's not working, what to measure, and how to measure it. As legendary management consultant Peter Drucker famously said, "what gets measured gets managed." In addition to helping your team focus and grow the right parts of the business, metrics are often the first thing potential investors will ask to see during a fundraise.
"What gets measured gets managed."
So how do you know what metrics to measure, and how to measure them? We've laid out the top basic metrics below to get you started.
Bookings are the value of contracts between companies and customers. Bookings are a contractual obligation for the customer to pay the company, but are not recognized as revenue until the service has been provided.
Billings are calculated by taking revenue from one quarter and adding the change in deferred revenue from the prior to the current quarter. Billings are a far better indicator of the health of your business as compared to traditional revenue as billings include the cash component from revenue that has been booked but not yet recognized.
Gross and net retention are two of the most important measures to track for recurring revenue businesses.
Gross retention is a highly punitive measurement that includes churn and contractions but ignores new revenue from existing customers. The formula for gross retention is as follows:
[Monthly Recurring Revenue (MRR) at Start of Month - Churn - Contractions] / [MRR at Start of Month]
Net revenue retention is less punitive. Net retention includes all of the components of gross retention but also includes expansion. The formula for net retention is as follows:
[Monthly Recurring Revenue (MRR) at Start of Month + Expansion - Churn - Contractions] / [MRR at Start of Month]
Sell-through rate is the number of units sold in a period divided by the number of those items at the beginning of the period. Sell-through rates are a key operating metric for businesses that buy inventory and can reflect the capital efficiency of the business. Sell-through rates are also a reflection of the quality of the inventory.
There is a reason that investors value recurring revenue at higher multiples than non-recurring revenue -- the gross margins for recurring revenue are frequently higher, and recurring revenues after the first year are typically not burdened by the same sales & initial support costs required to get new customers in the door.
Investors typically focus on ARR, or annual recurring revenue. This number can be annualized based on current run rate but should not include anything other than strictly recurring revenue.
Other types of revenue are not contractually recurring but do re-occur at a predictable rate. For example, one-time professional services revenue may attach to recurring revenue at a highly predictable rate depending on your business model.
Breaking out contribution margins for all of these types of revenue can paint a more accurate picture of how your company will scale.
GMV is the total sales dollar volume of merchandise transacting through your business and is especially applicable to marketplace businesses but does not apply to all business models. GMV can provide visibility into the broader activity your business is generating but is not the same as revenue. For GMV businesses, revenue is the portion of GMV that the marketplace "takes."
CAC (Customer Acquisition Cost) ... Blended vs. Paid, Organic vs. Inorganic
Customer acquisition cost or CAC represents the total cost to acquire customers on a per user basis. CAC metrics can vary widely by business model and can be very difficult to calculate.
For this reason, many investors focus on paid CAC -- or the total acquisition cost divided by the number of new users acquired through paid marketing -- to adjust for the complexity introduced by users who organically join the business without any customer acquisition spend. Isolating these holdouts provides greater visibility into the cost to require the next incremental customer, which ultimately is the primary benefit offered by a CAC metric.
ARPU is defined as total revenue divided by the total number of users (or seats) for a specific period. ARPU reflects the value of individual users on your platform and can provide visibility into the viability of various go-to-market approaches -- for example, low ARPU businesses frequently do not support a heavy boots on the ground approach to winning new customers.
Average Revenue Per User is valuable to measure over time as this provides visibility into the extent to which you are selling existing customers new services, bringing on larger average customers over time, or even successfully raising prices once customers have joined the platform.
Gross profit calculations vary by company but effectively include all costs directly tied to generating revenue. Gross margins play a big role in how growing companies scale. Higher gross margins imply higher contribution margins from growing revenue and typically will scale over more fixed operating costs, creating additional cash that can be reinvested into the business. This is known as operating leverage.
Total Contract Value (TCV) vs. Annual Contract Value (ACV)
TCV is the total value over the entire duration of a contract. TCV should include value from one-off revenue streams, including professional service fees, one-time charges, etc. TCV is a useful tool for understanding the total contract values that have been booked by the business during any given period.
ACV measures the value of the contract over a 12-month period. ACV is useful for understanding the unit economics of any given contract as well as for budgeting / resource planning.
Lifetime value represents the total net gross profit from a customer over the life of a relationship. The LTV calculation includes gross margins and retention statistics and can be used to toggle your spend on customer acquisition costs (CAC).
Here's how LTV is calculated:
LTV = Contribution margin per customer divided by the average churn rate for customers.
Contribution Margin = revenue per customer minus variable costs per customer -- so gross margins but also inclusive of selling, administrative, and any other operational costs associated with serving the customer.
Average churn rate = your annual churn rate, which is defined below