Summary:
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- A Profit & Loss (P&L) statement is crucial for startups, providing insights into growth, spending, profitability, and cash flow.
- Analyzing revenue growth is essential, ensuring it aligns with the narrative presented in the pitch deck.
- Understanding the relationship between growth and spending, especially in sales and marketing, is vital for evaluating efficiency.
- Gross margin and cash burn rate are key indicators for assessing profitability and financial health, guiding investment decisions and strategic planning.
What story does your P&L tell?
The P&L, or Income Statement, is the most informative and important financial statement for most startups. When I was an investor, it was the first amendment I looked at during diligence, and the one I spent the most time reviewing. If your pitch deck tells a different story than your P&L, prepare to get scrutinized in diligence — if you even make it that far.
So what story does your P&L tell? At a high level, it tells investors how much you’re growing, how much you’re spending, and what you like to spend money on. When you review your P&L, you can follow this story by asking the following four questions:
- How fast are we growing?
- How much are we spending to generate growth?
- How profitable can we be at scale?
- How much cash are we burning?
Question 1: How fast are we growing?
Growth is necessary for success in the startup world. If you are generating revenue, your growth is reflecting by your revenue on the P&L. Investors don’t like it when you tout high growth in your pitch deck but the P&L shows stagnating revenue.
- Line item: revenue
- Pro Tip #1: ensure your revenue is broken out by product/service. This shows you which offerings are scaling vs. stagnating, and ensure your P&L tells a more holistic story about the business.
- Pro Tip #2: for SaaS and subscription companies, look for consistent upward trends. A dip in subscription revenue indicates that churn outpaced growth in that period. If you see a dip and don’t believe you have a churn problem, you need to dive deeper with your accountant.
Question 2: How much are we spending?
To contextualize growth, you must know how much the company spends acquiring customers. Growing 2x annually is great when you spend very little on sales & marketing (S&M), but it’s subpar if your sales & marketing expense is 10x your revenue.
It’s not possible to calculate sales efficiency by simply comparing revenue growth to sales & marketing spend. This is called the Magic Number for SaaS Companies.
- Line item: total sales & marketing expense
- Pro Tip #1: ensure your S&M expenses are grouped into one category on the P&L — and include personnel costs in that category. You want one “total S&M expense” line in your P&L that captures all growth spend, so investors can compare this year against your top-line growth and use it to feed Customer-Acquisition-Cost (CAC) calculations.
- Pro Tip #2: your S&M expenses should be broken out into logical channels within this category (e.g.: personnel, paid ads, PR, conferences, etc.). When top-line growth picks up, you can see which growth investments are driving that growth. Investors can also see that you’re tinkering with the growth model and using data to dictate decisions, rather than simply throwing money at the problem.
Question 3: How profitable can we be?
Startups that raise venture capital are generally expected to be unprofitable for a long-time. At some point, however, every company must turn profitable to succeed. For unprofitable companies, the best indicator of future profitability is Gross Margin. If you can sell your product for far more than it costs you to make it, you can usually become quite profitable at scale.
- Line item: gross margin
- Pro Tip #1: consistency is key! Your gross margin should not vary significantly month-over-month unless your revenue mix is changing along with it. Investors want to see clear validation of unit economics — in other words, your P&L should confirm exactly how much profit you make when you sell a new unit or add a new customer.
- Pro Tip #2: align COGS expenses with revenue categories when possible. This shows investors which products/services are most profitable for your business, and helps to explain why your overall gross margin may be higher or lower than expected. A common example would be separating hosting, customer support, and implementation COGS for a SaaS business — hosting and support are ongoing costs, whereas implementation occurs upfront only. Early stage businesses in high growth mode may have lower blended gross margins, as a high % of their customers are still being onboarded. Investors need to see this so they model Lifetime Value (LTV) appropriately and give you credit for achieving a high GM% over the course of a customer’s lifetime.
Question #4: How much are we burning?
Cash is the lifeblood of all startups. When you’re raising, investors look at burn for a variety of reasons. For one, it shows them your true urgency for raising — if your burn is high and you’re low on cash, they know they have leverage. More importantly, perhaps: it shows whether you have a proven history of using capital wisely to maximize progress within your budget. If you’re growing modestly while burning very little cash, investors may buy-in to the notion that you can ramp-up growth and hit more milestone with a new investment. David Sacks’ Burn Multiple quantifies this concept for SaaS companies.
- Line item: net income
- Pro Tip #1: understand the difference between cash and accrual accounting. If your books are kept on an accrual-basis (as we recommend), your net income won’t equal your change in cash — and that’s OK! Cash will fluctuate month-to-month based on the timing of payments, but over time it should even out to be similar to net income. If your cash balance consistently decreases by more than your net income, you may have a collections problem, or you may be capitalizing too many expenses.
- Pro tip #2: burn is meant to be forward looking. Don’t just look at your net income from last month and assume it will carry forward — consider which expenses are one-time vs. recurring, and factor in changes like new hires or layoffs. I like to use average burn from the last three months when I calculate runway, as this reduces sensitivity to one-time items that create variance month-to-month. Better yet: OpStart’s fractional CFOs can build a complete operating model that factors in expected growth, one-time expenses, new hires, etc. to give you a more detailed view of runway.
Bonus tips for your P&L reviews:
- Have a clear chart of accounts: break out expenses by department, break out revenue by product/service, and remove any unnecessary or immaterial line items. Think of what categories you would use to build a company budget — your P&L should show similar categories so you understand what transactions hit each account.
- Look at trends over time: always review a monthly P&L covering the last 12-months. When you compare last month vs. prior periods, it’s easier to identify oddities (“why did our payroll expense increase when we didn’t make hires?”) and spot key trends (“we’re spending more on marketing every month but growing at the same rate”).
- Understand your accounting methodology: check out our primer on cash vs. accrual accounting. You should understand how your revenue is recognized, which expenses are being capitalized, and whether your payroll expenses will jump when you have three pay periods vs. two in a given month. This leads to the final tip…
- Engage and communicate with your accountant: you know our business best, so don’t be afraid to questions your accountant when things look off, or request changes when the format is tough to follow. Doing this will ensure your books remain accurate and easy-to-follow. Conversely, you should listen to your accountant when they suggest changes (like a switch to accrual methodology) that may not be intuitive to you at first but are necessary for tax compliance and investor reporting.
