Know Your Numbers: A Financial and Funding Glossary for Founders
Over the years of working with up-and-coming founders, the New Voices team has encountered many founders looking to establish a financial foundation for their brands/companies. Many of whom don’t yet have the financial language to discuss their goals and/or growth with potential investors–we’ve got you covered.
New Voices is decoding “investor speak” by providing #newvoicesfamily members with definitions of terms they will encounter as they look to grow and scale businesses. Armed with these terms, calculation tools, and resource links, founders can now provide critical data points around their businesses to potential investors, funding institutions, or partners for growth.
Pro Forma Financials
Pro forma financial statements are projections of future expenses and revenues, based on a company’s past experience and future plans. These include three main documents; Profit and Loss (P&L), a cash flow statement, and a balance sheet. The information provided in these documents provides a clear picture of a company’s financial health and potential growth for potential investors.
- Profit and Loss Statement: a financial statement that summarizes the revenues, costs, and expenses incurred during a specified period.
- Cash Flow Statement: a financial statement summarizes the amount of cash and cash equivalents entering and leaving a company.
- Balance Sheet: a financial statement that reports a company’s assets, liabilities, and shareholder equity at a specific point in time. Balance sheets provide the basis for computing rates of return for investors and evaluating a company’s capital structure.
Important General Terms and Formulas
Burn Rate Calculations
The burn rate informs how much revenue is needed. The burn rate is an important metric for any company, but it is particularly important for startups that are not yet generating any revenue. It tells managers and investors how fast the company is spending its capital. There are two types of burn rates; net burn and gross burn:
- Gross Burn Rate: the total amount of operating costs it incurs in expenses each month. The gross burn rate is conservative. It considers only outflows.
- Gross Burn Rate = Monthly cash expenses
- Net Burn Rate: the total amount of money a company loses each month. Net burn rate considers both inflows and outflows.
- Net Burn Rate Formula = Monthly cash sales – Gross burn (Monthly cash expenses)
The cash runway is a metric that shows how long a company can remain in business before reaching $0. NOTE: Burn rate is required to calculate cash runway. The burn rate and cash runway go together for startups. Collectively, these calculations give businesses a holistic view of how quickly they will run out of money, for how long they will continue to do so, and whether they are required to make adjustments to reach their goals.
- Formula: Cash Runway = current cash balance/burn rate. *
Capital Expenditure (CapEx)
CapEx is money a company uses to purchase, maintain, or expand fixed assets. These fixed assets are intended for long-term use–more than a year.
Customer Acquisition Cost (CAC)
A company’s CAC is the total sales and marketing cost that go into earning a new customer over a specific period.
- Formula: Customer Acquisition Cost = Cost of Sales and Marketing divided by the Number of New Customers Acquired.
Customer Lifetime Value (CLV)
A company’s CLV is the total income a business can expect to bring in from a typical customer for as long as that person or account remains a client. Customer Lifetime Value is calculated by multiplying your customers’ average purchase value, average purchase frequency, and average customer lifespan.
- Formula: Customer Lifetime Value = Average Purchase Value x Average Purchase Frequency x Average Customer Lifespan*
* For more detailed information on calculating CLV visit this link.
EBITDA is an acronym for earnings before interest, taxes, depreciation, and amortization. It is one of the most widely used measures of a company’s financial health and ability to generate cash. It is a measure of profitability and allows investors to understand the sustainability of a company’s business model to continue operating without any additional investment. Especially in times of a bear market, investors will focus on profitability over growth.
Product pricing is the process of determining the quantitative value of a product based on both internal and external factors. Product pricing has a direct impact on the overall success of your business, from cash flow to profit margins to customer demand. The five most common product pricing methods are as follows:
- Cost-plus pricing: calculate your costs and add a markup.
- Competitive pricing: set a price based on what the competition charges.
- Price skimming: set a high price and lower it as the market evolves.
- Penetration pricing: set a low price to enter a competitive market and raise it later.
- Value-based pricing: base your product or service’s price on what the customer believes it’s worth.
Profit margin is one of the commonly used profitability ratios to gauge the degree to which a company or a business activity makes money. There are two types of profit margins, net and gross.
- Gross Margin: the difference between revenue (selling price) and cost of goods sold (COGS), divided by revenue. Gross margin measures a company’s gross profit compared to its revenues. The gross margin is expressed as a percentage. Investors tend to prefer that gross revenue is used in this calculation, so note which revenue is used (gross vs. net).
- Formula: Gross Margin = (Revenue (selling price) – Cost of goods sold) / Revenue*
- Net Profit Margin: measures how much net income is generated as a percentage of revenues received. Net profit margin helps investors assess if a company’s management is generating enough profit from its sales and whether operating costs and overhead costs are under control. It is calculated as the difference between revenue and expenses divided by revenue.
- Formula: Net Margin = (Revenue – COGS – operating expenses – interest – taxes) / Revenue*
Selling, General, and Administrative Expenses (SG&A)
SG&A, also known as Operating Expenses, are the costs of doing business. They include rent and utilities, marketing and advertising, sales and accounting, management, and administrative salaries.
Marketing and Retail Terms and Formulas
Return on Ad Spend (ROAS)
The Return on Ad Spend (ROAS) marketing metric measures the revenue earned for each dollar spent on advertising. It measures the cost-effectiveness of advertising campaigns and related spending. The higher a company’s ROAS, the better off it is in terms of profitability.
- Formula: Return on Ad Spend = conversion revenue / total advertising spend
Trade spending is defined as the amount of money brands pay a retailer for the purposes of selling a product to consumers at retail locations, which is typically measured as a percentage of sales. This spending can include slotting fees for preferential shelf display locations and discounts to consumers. For an in-depth breakdown of trade spending and how it works, watch our New Voices Learning Lab™ LIVE 58: “Mass Retail: Trade Spend” with Infinity Worlds.
The term seed capital refers to the type of financing used in the formation of a startup. Funding is provided by private investors—usually in exchange for an equity stake in the company or can be provided as non-dilutive capital, like grants. Much of the seed capital a company raises may come from sources close to its founders including family, friends, and other acquaintances. Seed capital is typically used to support the planning of a business up to the point when the company starts selling a product or service. It normally covers expenses until the business can make money and thereby attract more investors.
Trailing 12 Months (TTM)
TTM refers to the past 12 consecutive months of a company’s performance data used for reporting financial figures. By consistently evaluating trailing 12-month numbers, company financials can be evaluated both internally and externally. Analysts and investors use TTM to dissect a wide swath of financial data, such as balance sheet figures, income statements, and cash flows. The methodology for calculating TTM data may differ from one financial statement to the next. The formula for TTM revenue is simply to add up the previous four quarters of revenues to date. Quarters consist of three months based on the start of the fiscal year (i.e., Jan 1 – Mar 30 is considered the first quarter, Q1)
- Formula: TTM Revenue = current Q earnings + Q-1 earnings + Q-2 earnings + Q3 earnings.
- Example: TTM from Q1 2023 = Q1 2023 + Q4 2022 + Q3 2022 + Q2 2022
Valuation models are used to determine the worth or fair value of a company. Analysts take dozens of factors into consideration depending on the valuation method used, including income statements, balance sheets, market conditions, business models, and management teams. Examples of valuation models include:
- Market Multiple: common amongst venture capitalists, the market multiple approach values the company against multiples used in recent acquisitions of similar companies in the market or for a similar group of companies. Enterprise Value to Revenue or Enterprise Value to EBITDA multiples are the most frequent multiples used.
- Discounted Cash Flow (DCF): for startups or ventures that have yet to generate revenue, this approach is used as it relies on forecasting potential success. It estimates the value of an investment using its expected future cash flows. In other words, it projects how much cash flow the company will produce in the future and then, using an expected rate of investment return, calculates how much that cash flow is worth. A higher discount rate is typically applied to startups, as there is a high risk that the company will inevitably fail to generate sustainable cash flows. This method is heavily dependent on assumptions used to forecast future cash flows.
- Valuation by Stage: often used by angel investors and venture capital firms, this method assigns a range of valuations based on the maturity of the startup. This range is determined based on market data and then applied to new transactions.
- Cost to duplicate: this approach involves calculating how much it would cost to build another company, like the company being valued from scratch. This approach will often look at the physical assets to determine their fair market value.