Key financial metrics every startup should track
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Key financial metrics every startup should track
- 1. Key financial issues and metrics every startup should pay attention to Financial Fundamentals for Startups
- 3. +Gross Sales (GS) –COGS/COSS =Gross Profit (G *) –Selling Expenses –General Expenses –Administrative Exp. =Operating Profit (O ; EBITDA) ±Int, Taxes, Deprec, Amort +Gross Sales (GS) –COGS/COSS =Gross Profit (G *) –Selling Expenses –General Expenses –Administrative Exp. =Operating Profit (O ; EBITDA) ±Int, Taxes, Deprec, Amort +Gross Sales (GS) –COGS/COSS =Gross Profit (G *) –Selling Expenses –General Expenses –Administrative Exp. =Operating Profit (O ; EBITDA) ±Int, Taxes, Deprec, Amort +Gross Sales (GS) –COGS/COSS =Gross Profit (G *) –Selling Expenses –General Expenses –Administrative Exp. =Operating Profit (O ; EBITDA) ±Int, Taxes, Deprec, Amort Profit & Loss; Income Statement “Variable” Costs }SG&A: “Fixed” Costs From: _/_/_ To: _/_/_ * =“Profit” =Net Profit (N ) S G A © 2015 Blackerby Associates www.entrepreneurshipfundamentals.com Financial Fundamentals
- 4. P&L for Technology Companies +Gross Sales (GS) –COGS/COSS =Gross Profit (G *) –Selling Expenses –General Expenses –Administrative Exp}SGAR&D: “Fixed” Costs From: _/_/_ To: _/_/_ * =“Profit” =Operating Profit (O ; EBITDA) ±Int, Taxes, Deprec, Amort =Net Profit (N ) –Research & Dev. S G A R D& © 2015 Blackerby Associates www.entrepreneurshipfundamentals.com Financial Fundamentals
- 5. + Gross Sales (GS) –COGS/COSS = Gross Profit (G *) –Selling Expenses –General Expenses –Administrative Exp = Operating Profit (O ) ±Int, Taxes, Deprec, Amort = Net Profit (N ) + Gross Sales (GS) –COGS/COSS = Gross Profit (G *) –Selling Expenses –General Expenses –Administrative Exp = Operating Profit (O ) ±Int, Taxes, Deprec, Amort = Net Profit (N ) G GS %Gross Margin= G GS %Gross Margin= N GS %Net Margin= N GS %Net Margin= What is a Margin? From: _/_/_ To: _/_/_ * =“Profit” $1,000,000 - 600,000 400,000 O GS %Oper. Margin= O GS %Oper. Margin= © 2015 Blackerby Associates www.entrepreneurshipfundamentals.com Financial Fundamentals
- 6. Break-Even Point Fixed Costs (SG&A) $ Sales QuantityBreak-Even Units Break -Even Sales {Fixed Costs Fixed Costs (SG&A) Gross Margin % (G /GS) Operating Loss Operating Profit © 2015 Blackerby Associates www.entrepreneurshipfundamentals.com Financial Fundamentals
- 7. Break-Even Example @Gross Sales: $500,000 @COGS/COSS: -300,000 @Gross Profit: $200,000 @Gross Margin: 40% @Fixed Costs: $120,000 Fixed Costs (SG&A) Gross Margin % (G /GS) Bob’s Landscaping Mesa, Arizona P&L – Jan 1 - Dec 31 © 2015 Blackerby Associates www.entrepreneurshipfundamentals.com Financial Fundamentals
- 8. Two Key Concepts for Startups Burn rate: Total expenses per month, less revenue Runway: Number of months the business can survive at the current burn rate, with investor cash on hand or under contract © 2015 Blackerby Associates www.entrepreneurshipfundamentals.com Financial Fundamentals© Copyright Sam Chui – Used with permission.
Notes de l'éditeur
- The Profit and Loss Statement is also known as a P&L or Income Statement. They are just different names for the same thing. Like the Balance Sheet, the first thing to notice is the [Click] From: and To: dates at the top. Unlike the Balance Sheet, which has just an As Of: date, the P&L has two dates that describe a period in time, say January first to December 31st, or April 1 to June 30. The P&L describes what happened over time, as opposed to the Balance Sheet, which describes a specific point in time. Economists talk about “stocks” and “flows.” Stocks are like capital, while flows are like income. The Balance Sheet describes a company’s stocks – Assets, Liabilities and Equity – at one point in time. The P&L describes the company’s flows – income and expenses – over a period of time. [Click] The first line in the P&L is Gross Sales. It’s what David Faber on CNBC calls the “Top Line,” because it is the top line of the P&L. It is the total revenue coming into the company. [Click] Next is the Cost of Goods Sold – also called COGS – or the Cost of Services Sold – called COSS – depending whether the company sells products, services or both. These costs include both the materials and the labor used to produce products or services. In this program, we will refer simply to the Cost of Goods Sold, or COGS, but mean both COGS and COSS, as appropriate. The more products and services that are sold, the higher will be the COGS. That is why COGS are called [Click] “Variable Costs.” They vary with the amount of goods and services actually sold. When you start with Gross Sales, and subtract the COGS, [Click] you get “Gross Profit.” Gross Profit measures the efficiency of the production process, without counting any overhead or other expenses. We use the Greek letter Pi to abbreviate “Profit.” Those other expenses are grouped into three categories, called “Selling, General and Administrative” expenses, or [Click] “S-G-and-A.” [Click] Selling expenses include marketing, advertising, most printing, website hosting, and the salary, benefits and commissions of salespeople. [Click] General expenses are what most people call “overhead.” They include insurance, Internet service, office supplies, phones, rent, utilities, warehouse personnel and other costs that support the production and distribution of products and services. [Click] Administrative expenses are cost associated with administering the business rather than creating and selling products and services. They can include accountants, attorneys, bookkeepers, consultants, and top executive salaries and benefits. SG&A expenses are also called [Click] “Fixed Costs.” While they are not exactly fixed, they are generally predictable month-to-month. Why do we group these expenses into the three categories of S-G-and-A? It’s because each has a different level of controllability. Selling expenses are completely discretionary. A company short on cash might cut selling expenses like advertising or sales reps. In the long run, cutting selling expenses might limit business growth, but it might solve a short-term cash flow problem. General expenses are usually more fixed. Rent is contracted at a certain rate. Utility bills vary with the season, and you may be able to conserve energy, but you have no control over the rate you pay. You might be able to cut your number of phone lines; you may get a better package from your cell phone provider; you might go paperless to save office supplies, but the economies you can achieve are limited. Administrative expenses are more difficult to manage. You need an accountant to file tax returns. You will need a lawyer when you eventually get sued. On the other hand, the first one to get shorted on payroll is usually the CEO. [Click] Wait a minute! My QuickBooks doesn’t categorize expenses into Selling, General and Administrative! That is correct. But you can change your QuickBooks Chart of Accounts to create the three new Expense categories. Then make all of your other Expense accounts into subaccounts of either Selling, General or Administrative expenses. Your QuickBooks P&L Statement will then give you subtotals for each of your SG&A expense categories. [Click] Starting with your Gross Profit, as calculated above, [Click] subtract your SG&A expenses to get your “Operating Profit.” This is what David Faber calls “EBITDA,” “Earnings Before Interest, Taxes, Depreciation and Amortization.” Operating Profit is the earnings your company makes by buying and selling goods and services, including all the supporting expenses that make that possible. It’s the money you make from the core operations of your company. But Operating Profit is not necessarily money you can put in your pocket. You still have to account for what QuickBooks and others call “Other Expenses,” or [Click] the “Interest, Taxes, Depreciation and Amortization.” Of these four items, most small businesses need to consider only [Click] Interest and Depreciation. Interest can be either a positive or a negative, depending on whether you earn – or pay – more interest. Interest is not a core part of your business operations, unless you are in the lending business. It is a by-product of the other things you do, whether you have investors or borrow money, or whether you pay by check or credit card. Depreciation is affected by whether you buy or lease equipment, not how you use that equipment to make money. And, as noted earlier, depreciation is a non-cash transaction. But it does reduce your taxable profits, and therefore your taxes. Rules about depreciation methods are complex, so consult a tax accountant. Taxes referred to here are business income taxes, not payroll taxes, property taxes or sales taxes. Most small businesses don’t pay business income taxes, because they are either “Subchapter S” Corporations or Limited Liability Companies that, for tax purposes, look like partnerships. For these types of business entities, the taxable profits or losses pass through to the owners, who declare them on their personal tax returns. In any case, business income taxes are more about strategies to avoid them than they are about the actual operations of the business, which is why they are separated out as “Other Expenses.” Amortization in this context is an accounting concept that mainly affects minerals companies. After you add or subtract the Interest, Taxes, Depreciation and Amortization, [Click] you get “Net Profits.” This, finally, is money you can put in your pocket. It is the true “bottom line.” [Click]
- Technology companies’ P&Ls may look a bit different. In addition to [Click] Selling, General and Administrative expenses; they also have [Click] Research and Development – called “R-and-D” – expenses. Technology companies typically spend to develop new products and services before they start generating revenues. These expenses include labor costs for scientists, engineers, technicians and programmers, as well as laboratory equipment, computers and supplies that support R&D activities. So technology companies have [Click] “S-G-A-and-R” so-called fixed costs. These costs are somewhat discretionary, but long-term reductions in R&D expenses can lead to long-term reductions in profits. By segregating its R&D expenses, a technology company can distinguish normal operating expenses from their R&D investments. Isolating these expenses may also help the company apply for special tax treatment. Consult a tax accountant or attorney for more information about “R&D tax credits.” [Click]
- One of the most valuable things about the P&L Statement is the ability to calculate margins. A margin is the percentage that each profit line is of Gross Sales. Let’s look at Gross Profit, the result of subtracting COGS from Gross Sales. [Click] Divide the Gross Profit by the Gross Sales, and convert the result to a percentage, you get the Gross Margin. So if [Click] Gross Sales are $1 million dollars, and [Click] COGS is $600,000 dollars, the [Click] Gross Profit is $400,000 dollars. [Click] Let’s calculate: Divide the [Click] Gross Profit – $400,000 dollars – by the [Click] Gross Sales – $1 million dollars – you [Click] get point 4-0. Convert it to a percentage, and you get 40% Gross Margin. That means that 40 cents of every dollar of sales is available to pay for the SG&A, and have money left over for profits. This measure – Gross Margin – allows you to compare your goods-and-services-producing operations quarter-to-quarter, year-to-year, and if data are available, against competitors in your industry. The Gross Margin may be very different for different types of companies. Retailers want to see gross margins of 50% or more. Many manufacturing companies will want their Gross Margin to be 40% or more. A software company may have a Gross Margin of over 90%, because the cost of having a customer download software is almost nothing! Similarly, you can calculate [Click] an Operating Margin by dividing the Operating Profits by the Gross Sales, and converting it to a percentage. Again, you can use the Operating Margin to compare your overall operational performance quarter-to-quarter, year-to-year, and against other firms in your industry. Using our example company with Gross Sales of $1 million dollars, a Gross Profit of $400,000 dollars, and [Click] SG&A expenses of $300,000 dollars, then the [Click] Operating Profit is $100,000 dollars. Again, [Click] let’s calculate: The [Click] Operating Margin is $100,000 dollars, divided by the [Click] Gross Sales, $1 million dollars, [Click] giving us point 1-0, or 10%. This measure tells the company that, for every dollar of sales it achieves, ten cents will go to its Operating Profit. And, of course, you can also calculate [Click] a Net Margin by dividing the Net Profits by the Gross Sales, and converting it to a percentage. Use the Net Margin also to compare overall performance quarter-to-quarter, year-to-year, and against industry averages. Referring to our example again, Gross Sales are $1 million dollars, and Operating Profits are $100,000 dollars. Then, if Interest, Taxes, Depreciation and Amortization total a [Click] minus $20,000 dollars, the Net Profit is [Click] $80,000 dollars. [Click] Let’s calculate: Divide [Click] the $80,000 dollars Net Profit by [Click] the $1 million dollars in Gross Sales, and you get [Click] 8%. For every dollar of sales, the company earns 8 cents in Net Profits. [Click] So we see that we can calculate a margin for any of the three levels of profits, [Click] Gross Profit, [Click] Operating Profit, and [Click] Net Profit. Each of these margins can tell us whether our performance is improving quarter-to-quarter or year-to-year, or in some cases, when the data are available, in comparison to our industry peer competitors. [Click]
- Another key concept that you can derive from the P&L Statement is your Break-Even Point. How much do you have to sell in order to break even? Would knowing the break-even point be useful to you? Using the information in your P&L, you can figure out your break-even point, in terms of either dollar sales or unit sales. This graph shows the amount of sales, or dollars, up the left side, and the quantity of goods sold across the bottom. [Click] The red line represents your fixed costs, or SG&A. No matter how many units you sell, you are going to face approximately the same fixed costs every month. [Click] The blue line represents your variable costs, or COGS. The more you sell, the more you will spend on these costs, because they represent components of each unit sold. Now we are going to add the variable costs to the fixed costs. We add these costs by [Click] moving the variable cost line vertically until it just covers the fixed cost line, to get a new purple line called “Variable plus Fixed Costs.” And the Fixed Costs line fades away. [Click] The green line represents your sales. The key to this line is that it is steeper than the purple “Variable plus Fixed Costs” line. The difference in steepness represents your markup. Where the two lines intersect [Click] is the break even point. At this point, you cover the fixed costs, and you cover the variable costs you incurred along the way to covering the fixed costs. To the [Click] left of the break-even point, you lose money, an Operating Loss, and to the right of the break even point you make money, an Operating Profit. So how do you calculate exactly where the break-even point is? The answer is [Click] this formula: Divide the fixed costs, or SG&A, by the Gross Margin. We learned earlier that the Gross Margin is the Gross Profit divided by Gross Sales. Each of these numbers is derived from the P&L Statement [Click]
- Let’s look at an example, back to Bob’s Landscaping. [Click] Bob’s Gross Sales are $500,000 dollars. His [Click] COGS is $300,000 dollars, so his [Click] Gross Profit is $200,000 dollars. His Gross Margin is therefore $200,000 dollars, divided by $500,000 dollars, [Click] or 40%. [Click] Bob’s Fixed Costs – SG&A – are $120,000 dollars. What is his Break-Even Point? Looking at the formula, let’s [Click] do the calculations. [Click] Bob’s Fixed costs are $120,000 dollars. [Click] Divide that number by his [Click] Gross Margin, 40%, or point 4-0, do the math and the answer is [Click] $300,000 dollars. That is Bob’s break-even point. Now Bob charges an average of [Click] $80 dollars to do mowing and trimming for a typical suburban yard. Doing more math, divide the $80 dollars per yard into the $300,000 dollars Break-Even Point, and he would have to work [Click] 3,750 yards per year, or 15 yards per workday to achieve his break-even point. Three crews working full-time, each doing five yards per day, would meet that break-even. In reality, Bob has between three and five full-time crews, depending on the season, some working large commercial accounts, raising his total revenues well past his break-even point to a cool half-million dollars! [Click]
- If your business is a startup, in the process of developing products and services, or growing your market, you need to understand two additional concepts: [Click] “Burn rate” is the amount of money you are burning through each month. It is the total of all your expenses, both variable expenses, or COGS, and fixed costs, or SG&A. You can subtract any cash revenues you may generate to reduce your burn rate. [Click] “Runway” is the number of months your business can survive given the current burn rate. In the early startup stages, your business survives using investor cash, either from the “four F’s” – Founder, Family, Friends and Fools – or from angel or venture-capital investors. Like an airplane, when your business gets to the end of the runway, [Click] it will either fly, or crash and go DROOM. Remember DROOM? “Don’t run out of money!” [Click]