Paul Bianco, Founder and CEO at Graphite
As a CPG startup founder, it’s easy to get swept up in your investors’ financial expectations. Investors will ask a founder for a variety of complex reports and metrics to evaluate your organization’s performance.
However, having a robust financial strategy isn’t just to impress potential investors—it’s also to help your team make smart decisions internally and ultimately grow your organization.
One of the key components of financial modeling for CPG startups is understanding your organization’s unit economics. Accurate and straightforward unit economics calculations serve as the backbone of your financial strategy, and they’ll help tell your startup’s story to investors.
Here’s what to keep in mind when calculating the unit economics of your CPG startup.
Are You Calculating Your Gross Margin Correctly?
Understanding your gross margin is a key component of unit economics. However, many CPG startups don’t calculate gross margins correctly.
In simple terms, gross margin is revenue minus the cost of goods sold, divided by revenue. This metric is so important because it indicates how much revenue from each sale is going to business costs. Measuring your gross margin month-over-month gives you a baseline look at your operations and profitability.
Unfortunately, many CPG startups underestimate the cost of goods sold, which leads to incorrect gross margin calculations.
For a direct-to-consumer or Shopify brand, you need to consider not only the cost of producing these goods but also:
- The cost of shipping and 3PL services.
- The cost of returns and chargebacks.
- Any other directly related fees and operational costs.
In addition to your gross margin, consider your total contribution margins for an even closer look at your expenses. Contribution margins use a similar equation to gross margins but factor in the cost of acquiring customers in addition to the cost of goods sold. This allows you to compare revenue to your fixed operating costs rather than variable costs.
Many startup founders worry that measuring these expenses accurately will make their margins look worse from an investor’s perspective. However, there’s no point in obstructing anyone’s view of your organization’s financials, whether it’s yours or an investor’s.
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The Most Popular Metrics May Not Be the Best
One of the biggest challenges in financial reporting for any CPG startup is deciding which metrics to focus on and how to present your financial data. While there are plenty of buzzy metrics floating around the CPG industry, they may not be your best bet to showcase what your startup has and will go on to achieve.
Lifetime Value (LTV)
Many organizations use customer lifetime value as a key metric in their financial models. However, LTV is highly subjective and doesn’t provide investors with much concrete information about your startup’s financial future.
From an investors’ perspective, LTV is also not used consistently between organizations, making it difficult to compare projections. For example, some startups measure a 2-year lifetime value, while others have a lifetime value of 5 or more years.
If you present LTV; do so in a visual format where you can see the cumulative gross profit derived from the cohort or representative customer over a time horizon.
Return on Ad Spend (ROAS)
Return on ad spend, or ROAS, is another popular metric that is often overvalued by startups. While this metric is an essential part of any marketing strategy, the way it’s calculated doesn’t provide an effective long-term look at your margins.
Marketing leaders often look at top-line revenue as an indicator of ROAS, but what I would suggest is to look at gross profit. This gives you a clearer picture of the true return you’re receiving from your ad dollars.
Because of the inconsistent execution of this calculation, just like LTV, ROAS may not be the most compelling metric to refer to.
The Best Metric: Cohort Analysis
Instead of using these overvalued metrics, use a cohort analysis to dive deeper into your financials. This gives your team and your investors a more granular view of your startup, supporting more strategic decision-making.
Cohort analysis involves breaking customers and purchases into groups to identify trends. This gives both your team and your investors a more detailed and informative look at your financial data.
Instead of broad stats, this can help trace your metrics to specific actions and investments.
For example, you might look at purchases from first-time customers from a specific month and track their future purchasing behavior over time. You could also look at behavior through the lens of location or demographics.
Can We Make These Calculations in the Early Stages?
It’s never too early for your CPG startup to start making unit economics calculations, even if you’re pre-launch.
If you haven’t launched, you might not know the ins and outs of customer behavior, but you will be able to build projections based on industry norms and trends.
You might not know the exact numbers to expect, but you will know, for example, whether your gross margins will be closer to 40% or 70%, and build projections from there. It’s also helpful to talk to potential customers and put yourself in their shoes during the early stages of your startup.
It May Be Time to Bring in a Financial Expert
Bringing a financial expert into the picture early on will help you dive even deeper into your unit economics, make more accurate projections, and improve your long-term planning strategy.
The earlier you can bring in an expert, the more value you’ll get out of the investment long-term—plus, you’ll know who to call in a financial emergency.
At Graphite, we provide expert accounting services tailored to CPG startups. Over the years, we’ve supported some of the most successful eCommerce and consumer brands. Whether you need help building a financial model, need to prepare for fundraising, or just need help with your year-end taxes, we’re here to help. Get in touch with our team.
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