Essential metrics for evaluating your startup’s health

Key Takeaways

• When analysing your business, brevity and simplicity are your friends. Don’t get bogged down in too much data.
• Focus on these KPIs: revenue, cost of goods sold, gross margins, marketing expenses and operating profit. They’ll determine your most critical metric: contribution margin.
• Ensure future projections are grounded in historical trends — not hope and optimism.

It’s a typical assumption made by early-stage founders that investors want to see detailed finances. They can often get bogged down in the data. Many founders come to pitch meetings with 100-line item spreadsheets including long-term future expenses.

Instead, you want to present data that shows you’ve got a good business on your hands, even if it’s not profitable yet. A simple and effective approach is to share metrics from the last two years, with an additional projection just one year into the future.

A simple spreadsheet to validate your business model

The simple sheet below gives VCs a quick overview of where the company is and whether your business model is moving toward its profit goals. It doesn’t waste time trying to predict things that are irrelevant or out of your control.

Having a detailed data sheet is useful for your day-to-day activities, bookkeeping and for satisfying any VCs who ask for a more detailed overview. However, it is not necessarily the best thing to present in your pitch.

Download a working version of the KPI spreadsheet.

What is listed in this simple spreadsheet will vary slightly depending on your business. For example, a hardware company would reflect inventory management. A company that sells entirely via self-service e-commerce would not include sales-related expenses.

However, in all cases, these five figures are essential:

1. Revenue
2. Cost of goods sold
3. Gross margins
4. Marketing expenses
5. Operating profit

This particular set of metrics shows your prospective investors a clear storyline, and they will quickly spot the underlying patterns that matter. Plus, it always makes for a great discussion.

What’s your contribution margin?

One of the most important insights is your underlying contribution margin. A simple definition: your gross margin (revenue minus the cost of sales, such as parts and factory labour) minus sales and marketing costs.

It’s well known that some startups lose money in the early stages, as they build towards scaling and becoming profitable.

However, whether that happens or not, comes down to your contribution margin. The contribution margin tells you how well your products are helping cover fixed costs — things like salaries, property taxes and general admin costs for payroll and IT.

If your contribution margin exceeds these basic costs, your company is likely to have an operating profit.

Here’s an example. A fast-growing Series-B startup has £10 million in gross margin profit but spends £20 million on sales and marketing. That’s a negative contribution margin of 50%.
However, that’s OK because in the early stages of your business, it’s not easy to win customers for the first time. And ideally, those customers will buy from your startup for many years without as much marketing and sales investment.

Let’s say it’s three years later, gross margins have grown to £40 million while sales and marketing costs are £30 million. That’s a contribution margin of 25% - enough to help cover the fixed costs mentioned previously.

If the gross margin grows to £40 million but so does the cost of sales and marketing, the company’s sales are still not “contributing” to reaching operating profitability.

Investors like to see operating profit, or its potential in the near future for a few reasons:

1. It demonstrates your business’s financial health and stability.
2. It can be an indicator of a competitive advantage.
3. Later down the line it’s a key measure when analysing stock value.
4. Your profit is shared with your investors should they invest in your business.

Even some high-growth firms may have negative contribution margins. A healthy Software as a Service (SaaS) company will typically aim to have a contribution margin of 25% or more.

Historical data is the best antidote against “magical thinking”

The simple KPI spreadsheet shared earlier is different to normal reporting in many ways.

Historical data helps factor in seasonality which is especially important for any consumer-focused company –– list the data by quarter to help see longer-term trends.

Showing real data will quickly expose any “magical thinking”. Founders filled with optimism and big plans can naturally make unproven assumptions about what the future holds. In a pitch meeting, investors will pull you up on that. Your data needs to support your business growth plans.

Takeaway: keep it simple

Whilst knowing all your numbers is essential to any pitch meeting, knowing the key figures is more important.

Use historical data to tell a story of how things are going and what the data says for the upcoming year.