Thread
10 mistakes you're making with financial metrics (and how to fix them):
1/ Putting Average Contract Value (ACV) on a pedestal
Contrary to popular belief, you don't need to sell big deals to Fortune 500 enterprises to be successful
@InvestiAnalyst points out how ACV is a vanity metric that is a byproduct of your business model, not a driver of it.
Contrary to popular belief, you don't need to sell big deals to Fortune 500 enterprises to be successful
@InvestiAnalyst points out how ACV is a vanity metric that is a byproduct of your business model, not a driver of it.
@InvestiAnalyst In fact, the world’s biggest and best software companies tend to have smaller ACV’s.
-Mongo DB <$25K
-Bill.com <$2K
-Dropbox <$1K
Remember: Increases in ACV aren’t free.
Usually to increase ACV, it means some other metric of importance gets worse, like CAC.
cc: @yourfaveVC
-Mongo DB <$25K
-Bill.com <$2K
-Dropbox <$1K
Remember: Increases in ACV aren’t free.
Usually to increase ACV, it means some other metric of importance gets worse, like CAC.
cc: @yourfaveVC
@InvestiAnalyst @yourfaveVC 2/ Relying on the P/E Ratio for big companies w/ other income
The price-to-earnings (P/E) ratio relates a company's share price to its earnings per share.
A high P/E ratio could mean a company's stock is overvalued, or that investors are expecting high growth in the future.
The price-to-earnings (P/E) ratio relates a company's share price to its earnings per share.
A high P/E ratio could mean a company's stock is overvalued, or that investors are expecting high growth in the future.
@InvestiAnalyst @yourfaveVC However, @BrianFeroldi points out how GAAP accounting forces companies to mark up their other income when their holdings increase in value, and down when their stocks fall
This throws off false signals as to the health of the underlying core operations of the company
This throws off false signals as to the health of the underlying core operations of the company
@InvestiAnalyst @yourfaveVC @BrianFeroldi 3/ Using EBITDA as a proxy for how much money is available to service debt.
Most businesses have maintenance capex.
If they don’t spend that capex, the business’s earning power will go down each year.
Most businesses have maintenance capex.
If they don’t spend that capex, the business’s earning power will go down each year.
@InvestiAnalyst @yourfaveVC @BrianFeroldi Per @10kdiver if you want the business to stay alive, what’s actually available to service debt is:
EBITDA - Maintenance Capex
or
Cash Flow From Operations + Interest + Taxes - Maintenance Capex
The businesses needs oxygen. Don't suffocate it.
EBITDA - Maintenance Capex
or
Cash Flow From Operations + Interest + Taxes - Maintenance Capex
The businesses needs oxygen. Don't suffocate it.
@InvestiAnalyst @yourfaveVC @BrianFeroldi @10kdiver 4/ Disregarding the quality of ARPU growth
Many software businesses maniacally focus on ARPU (Average Revenue Per User) and how it grows over time.
But overemphasizing growth in ARPU
without digging into account retention masks a potentially leaky bucket
Many software businesses maniacally focus on ARPU (Average Revenue Per User) and how it grows over time.
But overemphasizing growth in ARPU
without digging into account retention masks a potentially leaky bucket
@InvestiAnalyst @yourfaveVC @BrianFeroldi @10kdiver From talking with @AliTheCFO , if ARPU increases, but you’re losing users at a rapid rate, that’s not healthy or sustainable growth
You are on a treadmill and will need to keep spending to acquire new users
You are on a treadmill and will need to keep spending to acquire new users
@InvestiAnalyst @yourfaveVC @BrianFeroldi @10kdiver @AliTheCFO 5/ Using nonstandard definitions for ARR (Annual Recurring Revenue)
Contrary to popular belief, not all "revenue" is created equal.
Multi-year contracts with deep first-year discounting or volume ramps over time drive deltas between the first and last year's ARR.
Contrary to popular belief, not all "revenue" is created equal.
Multi-year contracts with deep first-year discounting or volume ramps over time drive deltas between the first and last year's ARR.
@InvestiAnalyst @yourfaveVC @BrianFeroldi @10kdiver @AliTheCFO Many companies will claim the larger, exit year Contracted ARR (CARR) as ARR.
But CARR will not track to current period GAAP revenue or billings
@lukesophinos says using a non-standard definition of ARR can lead to unexpected mark downs by investors during financing events.
But CARR will not track to current period GAAP revenue or billings
@lukesophinos says using a non-standard definition of ARR can lead to unexpected mark downs by investors during financing events.
@InvestiAnalyst @yourfaveVC @BrianFeroldi @10kdiver @AliTheCFO @lukesophinos 6/ Excluding Working Capital from ROIC
Many ignore working capital in calculations of ROIC (Return on invested capital)
Working capital includes all the capital in current assets and current liabilities (like accounts payable, and accounts receivables).
Many ignore working capital in calculations of ROIC (Return on invested capital)
Working capital includes all the capital in current assets and current liabilities (like accounts payable, and accounts receivables).
@InvestiAnalyst @yourfaveVC @BrianFeroldi @10kdiver @AliTheCFO @lukesophinos Depending on the business model there can be a lot of money tied up in the cash conversion cycle.
According to @MT_Capital1 to avoid overstating returns you should calculate as:
(Net Operating Profit After Tax) / (Working Capital + Property Plant and Equipment)
According to @MT_Capital1 to avoid overstating returns you should calculate as:
(Net Operating Profit After Tax) / (Working Capital + Property Plant and Equipment)
@InvestiAnalyst @yourfaveVC @BrianFeroldi @10kdiver @AliTheCFO @lukesophinos @MT_Capital1 7/ Mismatching revenues and costs when calculating CAC Payback Period
CAC (Customer Acquisition Cost) is what you spend in S&M (sales and marketing) to land a net new customer.
And CAC Payback Period is the number of months it takes to break even on that new customer.
CAC (Customer Acquisition Cost) is what you spend in S&M (sales and marketing) to land a net new customer.
And CAC Payback Period is the number of months it takes to break even on that new customer.
@InvestiAnalyst @yourfaveVC @BrianFeroldi @10kdiver @AliTheCFO @lukesophinos @MT_Capital1 Per @cjgustafson222 S&M costs should be lagged by the average sales cycle of the sales engine you’re measuring.
And Customer Support costs should match the current period.
The goal is to align the dollars you spent in the past to generate the sales (ARR) you are seeing today
And Customer Support costs should match the current period.
The goal is to align the dollars you spent in the past to generate the sales (ARR) you are seeing today
@InvestiAnalyst @yourfaveVC @BrianFeroldi @10kdiver @AliTheCFO @lukesophinos @MT_Capital1 Examples of lagging by segment:
Enterprise sales cycle of 180 days = 2 quarter S&M lag
Mid-Market sales cycle of 90 days = 1 quarter S&M lag
SMB sales cycle of 30 days = 0 quarter S&M lag
Enterprise sales cycle of 180 days = 2 quarter S&M lag
Mid-Market sales cycle of 90 days = 1 quarter S&M lag
SMB sales cycle of 30 days = 0 quarter S&M lag
@InvestiAnalyst @yourfaveVC @BrianFeroldi @10kdiver @AliTheCFO @lukesophinos @MT_Capital1 8/ Only measuring Sales and Marketing efficiency
LTV (Lifetime Value) to CAC (Customer Acquisition Cost) measures the efficiency of your go-to-market engine.
It shows you how many times over the average customer pays for itself.
However, it leaves out R&D and G&A spend.
LTV (Lifetime Value) to CAC (Customer Acquisition Cost) measures the efficiency of your go-to-market engine.
It shows you how many times over the average customer pays for itself.
However, it leaves out R&D and G&A spend.
@InvestiAnalyst @yourfaveVC @BrianFeroldi @10kdiver @AliTheCFO @lukesophinos @MT_Capital1 From talking to @thealexbanks consider using Burn Multiple for a more holistic view.
It determines how much the entire company is burning to generate each incremental dollar of ARR
And takes into account functions across the entire company, not just sales and marketing.
It determines how much the entire company is burning to generate each incremental dollar of ARR
And takes into account functions across the entire company, not just sales and marketing.
@InvestiAnalyst @yourfaveVC @BrianFeroldi @10kdiver @AliTheCFO @lukesophinos @MT_Capital1 @thealexbanks 9/ Relying on Accrual Revenue when making growth decisions
Accrual Revenue isn't actually cash.
It's a GAAP based accounting view of the world, looking at when revenue should be recognized for services delivered.
Accrual Revenue isn't actually cash.
It's a GAAP based accounting view of the world, looking at when revenue should be recognized for services delivered.
@InvestiAnalyst @yourfaveVC @BrianFeroldi @10kdiver @AliTheCFO @lukesophinos @MT_Capital1 @thealexbanks Accrual Revenue will almost always lag cash received from new business. It will lag both ARR and Billings.
From talking to @KurtisHanni If you make hiring and spending decisions based on it, you can cap growth and leave money on the table
From talking to @KurtisHanni If you make hiring and spending decisions based on it, you can cap growth and leave money on the table
@InvestiAnalyst @yourfaveVC @BrianFeroldi @10kdiver @AliTheCFO @lukesophinos @MT_Capital1 @thealexbanks @KurtisHanni 10/ Making bad benchmarking choices
@IAmClintMurphy frequently sees companies:
-Comparing themselves to bigger, more established players
-Comparing themselves to companies with different montetization models
-Looking at metrics in isolation
@IAmClintMurphy frequently sees companies:
-Comparing themselves to bigger, more established players
-Comparing themselves to companies with different montetization models
-Looking at metrics in isolation
@InvestiAnalyst @yourfaveVC @BrianFeroldi @10kdiver @AliTheCFO @lukesophinos @MT_Capital1 @thealexbanks @KurtisHanni @IAmClintMurphy For eCommerce and DTC businesses
@joe_portsmouth says common errors include:
-Disregarding the impact of seasonality on conversion rate (Q1 vs Q4)
-Disregarding the impact of one-time campaigns and sales on conversion rate (Black Friday)
@joe_portsmouth says common errors include:
-Disregarding the impact of seasonality on conversion rate (Q1 vs Q4)
-Disregarding the impact of one-time campaigns and sales on conversion rate (Black Friday)
@InvestiAnalyst @yourfaveVC @BrianFeroldi @10kdiver @AliTheCFO @lukesophinos @MT_Capital1 @thealexbanks @KurtisHanni @IAmClintMurphy @joe_portsmouth That's a wrap on misued financial metrics.
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If you enjoyed this thread, retweet it so other people can benefit!
Follow
@cjgustafson222
I tweet about:
• Financial metrics
• Business models
• What makes startups tick
@InvestiAnalyst @yourfaveVC @BrianFeroldi @10kdiver @AliTheCFO @lukesophinos @MT_Capital1 @thealexbanks @KurtisHanni @IAmClintMurphy @joe_portsmouth Join top vcs, tech operators, and financial analysts in their quest to discover what makes startups tick.
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Brian Feroldi @BrianFeroldi
·
Jul 18, 2022
Nice thread!