Tuesday, January 31, 2023
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Metrics that matter: 3 KPIs to track on the path to profitability

For the tech community, the rallying cry in 2022 was about moving from the growth-at-all-costs mindset toward emphasizing profitability.

We believe that in turbulent times, startups and scaleups alike need to ensure:

  1. They have sufficient runway to ride out a downturn without relying on large amounts of external funding.
  2. They are developing fundamentally healthy businesses with attractive economics and a cost structure built for efficient growth.

While every company is unique and it’s difficult to create a blueprint for must-track metrics across stages and business models, we’ve found three metrics that provide helpful green, yellow and red diagnostics amidst the deluge of metrics you can track:

Cash burn efficiency

Image Credits: Paris Heymann

The majority of startups and scaleups are focused on burning cash. It makes sense to, because building and scaling an organization requires meaningful investment, often before a company can generate enough revenue to pay the bills. The key is to ensure that burn is prudent and efficient.

One way to analyze whether progress toward profitability looks healthy is to analyze incremental profit margin from one period to the next.

In general, if you are earning net new ARR of $1 for each dollar spent, you are in a strong position — your net new ARR to burn ratio is 1, which is healthy relative to benchmarks. A ratio greater than 1.5x is best-in-class, and if it’s below 0.6x, a closer look may be warranted.

We view cash burn efficiency as an effective shorthand metric to keep an eye on. If you need to spend more than $2 to generate revenue of $1, it may be a signal that growth is being “forced” and is therefore unsustainable.

Incremental profit margin

Image Credits: Paris Heymann

Profitability is often discussed in absolute terms, but it’s important to remember that companies typically progress toward profitability over time. That progression can either be smooth, pointing to a strong economic core, or it can be more erratic, indicating that closer attention could be warranted.

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