Welcome to part three of Tandem Innovation Group’s first blog series: Startup Financial Management 101! In this four part series, we will be providing the basics on managing your startup’s finances. From breaking down key concepts, to providing tips, and illustrating through examples; this series is the go-to resource for entrepreneurs. Curated with the expertise of Tandem network professionals, we want to make it simple for you to understand your startup’s finances.
Today we are deep diving into unit economics and profitability. We will be explaining what it is, why it is important, and how you can execute it.
Is Your Business Profitable?
There are four levels to consider when evaluating whether or not your business is profitable:
What Are Unit Economics?
Unit economics are how much value each unit creates for your business. The definition of a “unit” varies depending on what kind of business it is. A unit could be a physical product sold, a contract, or even a subscription. The goal is to determine how much profit the unit produces.
There are two key concepts that determine profit generated per unit:
Contribution margin is used for one-time sales. Net customer lifetime value is used for repeated sales and long-term relationships.
Contribution margin is calculated as follows:
CM = sales per unit – variable cost per sale
Net customer lifetime value is calculated as follows:
Net CLV = total revenue over customer’s lifespan (CLV) – acquisition/servicing cost per customer
How Can You Optimize Contribution Margin & Customer Lifetime Value?
To optimize contribution margin and customer lifetime value, you need to break down each into smaller parts.
Contribution margin is composed of sales price per unit and the variable costs per sale. Increasing sales price per unit and/or decreasing variable costs per sale will optimise your CM.
Net customer lifetime value is composed of customer lifetime value and customer acquisition costs. Increasing the customer lifespan and/or reducing marketing/servicing costs per customer will optimise Net CLV.
That’s Not All!
This is only one part of our financial management series! Our goal at Tandem is to make it easy for you to establish a sound financial platform to build your business on. Our last posts looked at financial modeling and cash flow, so don’t forget to check those out. Next, we will be looking at cap tables and stock options; what they are, why they are important, and how you can execute them.