Investment KPI’s: How to Measure Business Performance
Understanding the performance of a business isn’t easy. There are hundreds of different metrics that can be considered, to measure business performance, each with its own strengths and weaknesses and each able to tell the reader about a specific component of the business.
When we’re asked to review the performance and the future direction of a business, we have a set of due diligence metrics that we favour. Which metrics’s or metric we choose to use depends on the specific business and the drivers behind the review but we’ve pulled together some of our favourites to help you navigate the most popular business metrics’s.
Why do metrics matter?
Metrics help founders, team members and investors make more informed decisions. For a founder and a leader, this can mean having the right data to see what’s working and what isn’t, the make the right decisions to make best use of the resources available.
For an investor, due diligence metrics’s provide the data points needed to make informed investment decisions and to help the companies that you’ve already invested in perform to the best of their ability.
What metrics should we be tracking?
There are a huge number of business metrics and metrics that can be tracked and the relative importance of each one will depend on the business and the question that’s being asked of it. At Prussel & Co we classify due diligence metrics into three main categories; Customer, Sales and Financial. Each of theses is then viewed in the context of key Market metrics.
1. Customer Metrics
Our view is that Customer comes first in any business. When we look at any company we start off by understanding their customers, who they are, how many of them there are, their behaviour and how they are changing.
- K-Value: The k-value measures the virality of the growth of the customer base for a business. Marketing is an expensive activity and high virality offers high potential for growth a low cost. Calculation: take the number of customers today plus all new users invites by our existing users (as of today) then calculate the ratio of new to old users and add one.
- Cohort Analysis: businesses and investors want to “sticky” customers. Customers that don’t just interact once but keep coming back for more. Cohort analysis is a measure of how customers “drop off” the product and allows us to deduce with a few other data points, how much it will cost to grow the business and the options open for growth. Calculation: take the number of customers joined in a week and analyse how many time they engage with the product/service every successive week.
- Churn / Customer Attrition Rate: the attrition rate/churn shows not just the number of customer that no longer interact, but the number of customers that actively choose the leave the business. Growing businesses need to be retaining existing customers as well as attracting new ones. Calculation: take the number of customers who leave / total number of customers
- Long Term Value (LTV): The LTV of a Customer is a metric that works in partnership with churn to show the ROI for each customer over their lifetime and the potential for growth. The challenge is that measuring “value” is notoriously hard. Calculation: take the total sales from the customer of there entire relationship with the business.
- Cost of Acquiring a Customer and Payback (CPA/CAC): The CPA/CAC tells us how expensive it is to attract a new customer. Investment is often used to acquire new customers and drive growth and hence the CPA / CAC allows us to understand what it will cost the business to grow. For our commercial due diligence, we like to understand CPA and CAC for each channel / marketing activity over time to see that the team are reviewing their activities and adapting behaviour accordingly. Calculation: total marketing spend / number of new users within given period of spend.
- Daily / Monthly Active Users: Simply having a large number of users doesn’t mean that they actually use a product or service. App based businesses are prone to this by attracting a large number of downloads driven buy a marketing campaign but quickly resulting in very few active users. Looking at Daily / Monthly Active Users shows us how engaged the customers is with the product and gives an indication of the trajectory of travel. Calculation: take the number of active customers in a given time period over total number of customers.
- Net Promoter Score: Although this required direct customer feedback which is more difficult and expensive to source, NPS shows the potential for virality and customer advocacy by understanding how customers feel about a brand or product and their likelihood to recommend it to friends. Calculation: take the proportion of customers that would recommend the product and business
2. Sales Metrics
Users are one thing but it’s important to understand how efficiently a company can people from prospects to paying customers. This is where sales metrics come in. These give us the underlying drivers of the current and potential future success of a company and are essential to driving and accurate valuation.
- Total vs. New Sales: Understanding historical and projected sales growth is essential to understanding the trajectory of the company. Percentages and actuals of new vs. existing customers add colour to see how the business is growing. Calculation: take the total number of sales to existing customers and the total number of sales to new customers in a given time period, each per day, week, month.
- Magic Number: A great metric for showing how effectively a company can scale sales and marketing to build sustainable profit growth. A magic number of 1 means that the last quarters sales and marketing spend will be earned back over the next 4 quarters in incremental revenue. A number above 1 shows our growth of revenue is greater than your cost of sales and marketing. Calculation: take the net growth of revenue over two quarters, times it by 4, and divided by total spend on sales and marketing in quarter one.
- Conversion Rate: the conversion rate for a business shows us how efficiently the business can turn a prospect into a paying customer. This can then be benchmarked against the industry in which it operates to show how competitive it is. This is particularly useful for online businesses where we can clearly see the total traffic and conversions to sales. Calculation: the percentage of potential customers that buy your product or service.
- Average Sales Price (ASP): This metric is useful to put others in context. High ASP typically means less frequent orders but more flexibility in CPA. Calculation: the averages price of a typical order.
- Average Sales Cycle (ASC): similar to ASP, this metric is contextual to help us understand the fundamentals of the business and the cycles in which a Customer buys. Calculation: The date the customer is first contacted to the date of the first purchase.
3. Financial Metrics
Financials should be at the heart of any business. While many start ups may be pre-revenue, it’s still important to have a clear view of how the business will make money, have a good grasp of the company’s balance sheet, P&L and statement of cash flows and be able to demonstrate traction to meeting you’re goals.
- Monthly Revenue Growth: The monthly revenue growth is similar to Total vs. new Sales above as it measures the increase in revenue per month. For the monthly revenue growth this indicates the trajectory of revenue growth however it doesn’t consider the size of revenue growth. Calculation: take the current months revenue, minus last months revenue and then divided by last months revenue.
- Margins: Margins show how the business can turn a £/$ of investment into profit. Theres a benchmark for most industries and investors will often compare a start-up investment to these benchmarks to understand the efficiency of the company. The challenge is that margins only show a point in time view of metrics and does factor in margin compression from increased competition that comes with scale over time. Calculation: take the total revenue minus the “costs of good sold” and divide by revenue. Net margin is similar however we also minus the total expenses for the business.
- Burn Rate and Runway: This metric is only applicable to early stage businesses that are loss making or will be loss making once an investment is made. Burn rate is important as it shows the efficiency of the business, when it will need additional capital and that the management clearly understand their financing needs and roadmap. Calculation: take the available capital and divide by monthly operating loss.
The above metrics focus on a specific business however it’s essential to review in the context of the market in which they operate. Market metrics help us do this.
- Total Addressable Market: this is the total size of the market the business operates in. The total addressable market metric matters as it shows us the potential of the business. We can the view the above metrics in the context of where the business could scale to ie. how big it could become.
- Average Wallet Size: this is the total amount a customer will spend in a given period. The average wallet size matters as this allows a business to understand where to price and for us to understand the price point of the product/service.
- Market Demand: this is the growth rate of the market the business operates in. Market demand matters as while some markets may be small at present, the high growth rates make them attractive target. Conversely, some large markets are in significant decline and these growth rates are important to add context to any investment decision.
The most appropriate metrics for any business will depends on the question that’s being asked of it. When looking at a company for investment, we utilise our due diligence methodology and the most appropriate metrics for the investment candidates business model and that fit with the questions being asked by the investor. If you’re looking to raise investment for your business then knowing your metricss is essential.
Remember that with any metrics data quality of king. Without quality data it’s impossible to make solid decisions.