What are some Maths formulas to help start-ups in their decision-making?
THE HANGAR Booster Programme highlights: Unit Economics
Contributed by Rebecca Tan Li Qi
Wondering whether to step on the accelerator or jam the brakes?
Unit economics, which describes a start-up’s revenue and costs in relation to an individual unit of production, can help a start-up to decide the next step for its growth.
With many key metrics to track and so many different hats to wear, start-up founders can find it overwhelming to quantify their progress. For instance, start-up founders may not have the interest or may not invest time to understand unit economics, which can cause them to lose data-driven directionality.
“[And] directionality is more crucial than anything else,” says Chris Sirisereepaph, a Partner at Saison Capital.
To ensure your start-up is steering in the right direction, here are 5 key metrics of unit economics to understand your start-up’s overall health and sustainability.
- Customer lifetime value (LTV) to customer acquisition cost (CAC) ratio: value of a customer to cost of acquiring a customer
(average monthly revenue per customer / monthly churn) / (total sales and marketing expenses / number of new customers)
An ideal LTV to CAC ratio should be 3:1. Any lower than this ideal ratio can mean that your start-up may not be sustainable in the long run if no improvements are made. If your current ratio is higher than the ideal, let’s say 5:1, it can mean that you are underinvesting in marketing and potentially giving your competitors an advantage.
2. Revenue growth: rate of growth of revenue
(current quarter revenue — prior quarter revenue) / prior quarter revenue
With data on your start-up’s revenue growth, you can better identify the specific channels that are responsible for increasing or decreasing your revenue. Subsequently, you can tailor your approach to focus on channels that bring in the most revenue for your start-up.
3. Sales efficiency: rate of spending on marketing to gain in revenue
(current quarter revenue / prior quarter sales & marketing costs)
The ideal sales efficiency should fall between 0.5 to 1. A start-up with a sales efficiency of less than 0.5 can mean that it does not have a sustainable and investable sales model. On the other hand, a ratio greater than 1 can potentially mean that you are underinvesting in sales and marketing.
4. Revenue churn: measure of lost revenue
(churned annual recurring revenue / opening annual recurring revenue for the period)
It’s challenging to pinpoint an exact revenue churn rate your start-up should aim for but as a rule of thumb, the closer your revenue churn rate is to 0, the more ideal it is.
5. Cash burn: rate at which company uses up its case
(start balance — end balance) / number of months
The main thing to keep in mind is that a high burn and high growth rate is good, but a high burn and low growth rate can be detrimental to your start-up.
Ultimately, unit economics “simplify a complex world into a single organising idea, a basic principle or concept that unifies and guides everything.” — Jim Collins
By understanding this single organising concept, it will help you become better equipped to generate revenue for your start-up.
(*Disclaimer: The above-mentioned metrics are more relevant for SaaS business models.)
Want to take your start-up to the next level but missed the application for this run? Reach out to us at firstname.lastname@example.org to find out more about our next run in October 2021!