Financial metrics can become weapons of mass destruction when used inappropriately. As Uncle Ben says to Peter Parker in Spiderman:
“With great power, comes great responsibility.”
-Uncle Ben, Sr. FP&A Director at Marvel Studios
Here are some common, but costly, mistakes I’ve seen FP&A teams make (and have even fell victim to myself):
1/ Using nonstandard definitions for ARR (Annual Recurring Revenue)
Not all "revenue" is created equal. Multi-year contracts with deep first-year discounting or volume ramps in the out-years drive deltas between the first and last year's ARR.
Many companies will claim the larger, exit year’s Contracted ARR (CARR) as ARR. It makes you look bigger than you are on paper. But over time, CARR will not track to current period GAAP revenue or billings.
Mostly advice: Using a non-standard definition of ARR can lead to unexpected mark downs by investors during financing events.
2/ Putting ACV (Average Contract Value) on a pedestal
Contrary to popular belief, you don't need to sell big deals to Fortune 500 enterprises to be successful.
ACV is a vanity metric that is a byproduct of your business model, not a driver of it.
In fact, the world’s biggest and best software companies tend to have smaller ACV’s.
Mongo DB <$25K
Bill.com <$2K
Dropbox <$1K
Mostly advice: Increases in ACV aren’t free. Usually to increase ACV, it means some other metric of importance gets worse, like CAC.
3/ Disregarding the quality of ARPU (Average Revenue per User) growth
Many software businesses maniacally focus on ARPU, and how it grows over time.
But overemphasizing ARPU growth without investigating overall account retention masks a potentially leaky bucket. It’s possible to game ARPU while losing a high volume of accounts.
If you find yourself in this predicament, you’re on a treadmill and will need to keep spending to acquire new users.
Mostly advice: If ARPU increases, but you’re losing users at a rapid rate, that’s not healthy or sustainable growth. You’ll want to stop the nose bleed rather than just plowing forward.
4/ Mismatching revenues and costs when calculating CAC (Customer Acquisition Cost) Payback Period
CAC is what you spend in S&M (sales and marketing) to land a net new customer. And CAC Payback Period is the number of months it takes to break even on that new customer.
S&M costs should be lagged by the average sales cycle of the sales engine you’re measuring. And Customer Support costs should match the current period. The goal is to align the dollars you spent in the past to generate the sales (ARR) you are seeing today
Examples of lagging by segment:
Enterprise sales cycle of 180 days = 2 quarter S&M lag
Mid-Market sales cycle of 90 days = 1 quarter S&M lag
SMB sales cycle of 30 days = 0 quarter S&M lag
Mostly advice: Don’t overburden yourself for costs that aren’t generating revenues today. Investors will give you (somewhat) of a pass when it comes to matching costs to future revenue generation.
5/ Cherry picking churn metrics for your Customer LTV (Life Time Value) calculations
Gross account based churn should be applied in your LTV calculations. Full stop.
If you are using net account churn, post reactivations (i.e., the customers you resurrect), you are artificially inflating the number.
The same goes for dollar denominated churn - relying on gross dollar retention or dollar renewal rate will almost always make you look better than you really are. This is because the higher spending, stickier enterprise accounts subsidize the smaller, churning SMB accounts from a dollar denominated basis.
Mostly advice: Instead of cherry picking churn figures to make your overall LTV look better, break LTV out by segment so you can speak to the nuances of each engine. It’s OK if your SMB engine has a lower LTV than your Enterprise segment.
Quote I’ve Been Pondering:
“Show me a happy man and I will show you a man who is getting nothing accomplished in this world.”
-Rich Cohen, The Fish that Ate the Whale
