How to calculate your unit economics
When it comes to running a successful business, there’s a lot more to it than just making money. Sure, turning a profit is important—but having good unit economics is even more important. And if you’re looking for investors, understanding your unit economics is key. So what is unit economics? How can you calculate your unit economics? And why does it matter? Let’s take a look.
Unit economics refers to the costs and profits associated with producing and selling individual units of a product or service. It looks at the cost of acquiring customers (CAC) versus the value these customers provide (LTV), as well as other factors such as churn rate and average order value. By looking at those metrics in relation to each other, you can get an idea of how your business is performing overall.
Calculating your unit economics requires analyzing data from multiple sources including customer acquisition costs, customer lifetime value, average order value, and more. Once you have all of that data, you can begin to calculate things like customer acquisition costs versus customer lifetime value (CAC:LTV). This will give you an idea of whether or not your business is sustainable over time. For example, if CAC > LTV then it means that it’s costing you more money to acquire new customers than they are providing in revenue over their lifetime—which isn’t a good sign.
On the other hand, if CAC < LTV then that means that you’re making money on each new customer that comes through the door—which is definitely something worth celebrating! It also helps measure the profitability of different products or services within your company so that you know which ones are worth investing in and which ones aren't performing as well as expected.
Let's say that your startup has $1 million in annual revenue. That's great—but what's even better is figuring out exactly where that revenue is coming from and how much it costs to generate each dollar of revenue (AKA “unit economics"). To do this, you first need to figure out how much it costs to acquire each customer (CAC). This could include things like advertising costs, salaries for salespeople/marketing professionals, etc. Then calculate the average order value (AOV) and the average customer lifetime value (LTV). The Average Order Value (AOV) tells you how much each individual sale was worth while the LTV gives an indication of how valuable a given customer may be over their entire lifespan with your company. Finally divide CAC by LTV - this will give you an indication of whether or not each new customer acquired is creating long term value for your business or not.
Unit Economics Matter Understanding unit economics has become increasingly important for startups seeking investment from venture capitalists and private equity firms because it provides insight into how sustainable their business model really is long-term. Good unit economics can be used as leverage when negotiating with potential investors because they know that any company with strong numbers will likely make them a return on their investment down the road - something they always look out for when evaluating potential investments! Having good unit economics also allows founders to have an informed understanding of where their business stands financially so they can plan accordingly and make decisions based on data rather than guesswork alone. Ultimately understanding unit economics gives entrepreneurs greater clarity around their businesses finances which leads them towards greater success down the line!
