Three Financial Concepts for Start-Ups

You don’t have to be an accountant to start a business but it certainly helps to be comfortable with numbers. And while every business owner should be familiar with profit & loss accounts and balance sheets, there are a few financial concepts that are particularly valuable for start-up founders.

CAC & LTV

Customer Acquisition Cost (CAC) and Life Time Value (LTV) are really valuable numbers that can be used as a quick test of the viability of a start-up early in the development of the business model. 

CAC is derived from the sales and marketing processes - how will sales leads be generated, managed and converted, what are the estimated sales and marketing costs and what are the likely conversion rates and how many paying customers will result. It’s calculated by dividing the estimated sales and marketing costs by the number of customers. 

LTV is derived from pricing and customer retention and is calculated by multiplying how much customers will pay and how many times they will buy. 

The LTV should be many multiples of the CAC to cover other operating costs and profit. A good rule of thumb is for LTV to be four times CAC. 

It’s ok that these are rough estimates at the start. They’ll improve in accuracy as the business model develops. The important point is to ensure that the gap between the two is big enough to build a sustainable business.

Cash Flow

A cash flow projection is an estimate of the future cash incomes and outgoings on a timed basis. Think of it as money going into and out of the bank account. If there isn’t enough money in the bank account to pay the bills when they fall due, the business will grind to a halt. 

A simple cash flow spreadsheet can be built by estimating all payments to be made and all payments to be received on a month by month basis; then calculating the difference between payments made and payments received for each month; finally calculating a running total from month to month.   

A good cash flow projection allows cash flow shortfalls to be anticipated in advance so that steps can be taken to reduce the outgoings or increase the incomes to eliminate the shortfall.

A cash flow projection is critical when it comes to raising investment. Investors want to know how much cash is required every month - the burn rate - and how long the investment will last - the runway. 

Capitalisation Table

The Capitalisation Table (Cap Table) is a list of shareholders and the equity they hold in the company. When the company is formed, the founders own 100% of the shares, and as funds are raised, the founders percentage is reduced as shares are allocated to investors. The number of shares issued and the impact on the founders ownership will depend on the agreed valuation of the company at the time of investment.

A projection of the Cap Table helps founders to assess how the ownership of the company will change and how their ownership will dilute through successive funding rounds. By projecting the size of investment rounds, and how successive investments will enhance the value of the company, founders can anticipate when their shareholding will hit significant thresholds such as 50% and 25% and can plan a strategy to maintain the highest level of ownership and control for as long as possible.

Needtheless to say, it's not possible to predict the future with any degree of accuracy. The real value in working on early estimates of CAC, LTV, Cash Flow and Cap Table is that they help founders to anticipate potential difficulties in advance so they can put plans in place to avoid them.