a16z Podcast

Navigating the Numbers

Jeff Jordan, David George, Caroline Moon, and Das Rush

Posted April 3, 2020

For any business, there are three core financial statements—the income or P&L statement, the balance sheet, and the cash flow statement. While these statements can show investors and the board how the business is doing, they can do more than just keep score on your business—they are one of the best tools you have to run it.

In this podcast, a16z General Partner Jeff Jordan, who previously ran several businesses and took a company public right after the 2008 financial crisis; David George, who runs the a16z Growth operation; and former CFO Caroline Moon, who led the a16z financial operations team, break down what the numbers do (and don’t) tell you, both in financial statements and KPIs. They cover the most common mistakes people make when it comes to understanding their numbers; how investors look at a company’s P&L; what metrics they use to determine if a business is healthy; and how founders can use the numbers to navigate in times of crisis.


Das: Hi and welcome to the a16z podcast. I’m Das, and this episode is all about what the numbers—both financials and KPIs—do (and don’t) tell you about your business.

Our guests are a16z General Partner and managing partner Jeff Jordan, who previously ran several businesses and took a company public right after the 2008 financial crisis; David George, who runs our late-stage venture operation; and Caroline Moon, who leads our financial operations practice helping companies with finance best practices and is also a former CFO.

We cover the most common mistakes people make when it comes to understanding numbers; what investors think when we look at a company’s profit and loss statements, and why; how investors use metrics to determine if a business is healthy; and how some founders may use them to navigate times of crisis.

We begin, though, with the basics of the three core financial statements – the income or P&L statement, the balance sheet, and the cash flow statement. The first voice you’ll hear after Caroline’s and mine is Jeff’s, followed by David’s.

Caroline: A startup will typically do cash accounting. That’s literally just, “How much cash did I have in the beginning of the period and how much should I have in cash at the end of the month?” That’s not the same thing as what a P&L should show because your P&L paints the picture of how your business did in a particular period of time and measurement, whether that’s quarterly or yearly. The cash flow statement reconciles that with what you actually collected. Everything that happens on that cash flow statement then ends up on your balance sheet.

The reason why it’s important to present it in that fashion is called generally accepted accounting principles, or GAAP accounting. It’s an apples-to-apples comparison across companies that everyone understands.

Das: When you are trying to figure out how a business is doing, what are the financials that you look at?

Jeff: Typically in early investing, you don’t emphasize financial metrics that much because usually there isn’t a mature go-to market organization. I tend to focus much more on KPI-type metrics, daily to monthly users, engagement, and things along those lines. Then the financials tend to emerge over time.

David: I care most about two very high level topics at the later stage. The first is can you demonstrate that you can have very persistent growth? Second, how profitable will you be when you reach scale? For later stage, high-growth companies, I spend less time staring at their balance sheet than I do KPIs, income statements, and cash flow.

Jeff: The main thing I look for in the balance sheet is the comparison for how much traction they have on the income statement and the cash flow documents relative to the amount that’s been invested in the company. For me, the most important balance sheet metric early on is how much capital has the company deployed to get to where they’re going.

How can you tell when a business is profitable?

Das: How do you know when a business is truly profitable?

Jeff: I think you go to unit economics and really understand them–but this is a lot of art as well as a good amount of science. Some of the most frustrating interactions I’ve had with companies are when their unit economics work but the business isn’t working. I had one that was capital efficient, the unit economics are working, they’re acquiring users, they’re profitable in three months, and the company was hemorrhaging cash. It turns out the unit economics weren’t actually working. The cash flow statement was the arbiter of truth and the analysis showed what the company had done on unit economics was wrong.

Caroline: I agree. I think lifetime value is one of those traps that people fall into. They’re assuming customers are going to stay for three or five years, so they have plenty of time to do the payback. That’s a key driver in whether or not your unit economics work.

David: There’s nothing that’s less consistent in the market than how lifetime value (LTV) to cost of acquisition (CAC) of the customer is defined. I always counsel companies that I like to see very transparent calculations for what goes into the LTV side and the CAC side. The LTV to CAC metric that I like to look at on the LTV side is gross profit, not revenue. Then I like to use a shorter duration, which is 3 years, than founders like to use, which is typically 5 years. My point is that 5 years is too uncertain and long of a period, whereas 3 years is much more visible. Then you use actual retention statistics that you’ve experienced in the past to project those 3 years.

Caroline: The thing that I really try to emphasize to founders when they talk about these kinds of metrics is this is not about showing investors; this is how you have to run your business. What am I spending on sales and marketing? What am I spending on my R&D? And how much am I spending on G&A? Is that the right level of investment that I should be making in my company? You need to be as honest with yourself as possible as to what all these things cost you and what you’re really generating in terms of revenue, because if you can’t be honest with yourself, you can’t run your business.

Common financial mistakes founders make

Das: What are some of the other common mistakes that founders make when presenting numbers that you’d like to help them correct or see them do differently?

Jeff: One tell for me when a business is probably struggling is when they come up with North Star metrics and KPIs, and when they come back to report on them a quarter later, they’ve changed. Then they come back a quarter later and they’ve changed again. I’ve found a little bit of pattern recognition when the KPIs change all the time. It’s largely because they’re not working and the company’s trying to navigate through it. For me, pick your metric, report on it, and ideally your understanding of the business improves over time as your metric and your models are either validated or unvalidated.

Finding truth in financials

Das: That leads us to an interesting question: How do you manage your own psychology so that the numbers are a tool, not this obsession where I want to reach my KPIs so I’m going to keep adjusting my KPIs so I do.

Jeff: The reason the three financial statements are so defined is because it’s truth-seeking. If you don’t want to let your investors or board know how bad things are, by not telling the truth to your key constituents, you often run the risk of not telling the truth to yourself. I’ve had a couple of founders where they sometimes fall prey to believing their own kind of machination and then the board and investors can’t help them based on the truth.

Das: What do the best founders do in challenging moments when the finances and the numbers aren’t going their way or they have to tell a difficult truth?

Jeff: They typically acknowledge it. They take it as, “The truth isn’t what I wanted it to be, so what can I do now to change the business to improve the truth?”

David: I’ve observed that some of the best founders of later stage companies are very careful not to drown themselves in KPIs. You can actually inundate yourself with KPIs. The very best ones pick out a handful of metrics that they think are the most important drivers of their business, and if they see those divert from where they would like them to be, they dig in from there. For example, Ali from Databricks always focuses on sales rep productivity because he believes that indicates the health of the business in many different ways. How well is the sales organization actually functioning? What are the market dynamics? What’s the competition doing? How is the product performing?

Jeff: I have companies that will present 50 pages of metrics based on the last quarter–and you’re just drowning. Which ones are really important?

Das: Are the one or two that matter the same for every company or does it depend on the nature of the company and the stage it’s at?

Caroline: I think some of them are the same. For instance, retention should matter to any business model. You spend money to acquire your customer base–how long are you hanging on to them?

Jeff: I find they are consistent by type of business. Marketplace metrics typically have a lot in common with each other, but they’re very, very different from e-commerce metrics. The key e-commerce metrics typically center around the efficiency of customer acquisition and LTV to CAC. A lot of marketplaces I work with don’t spend a penny on customer acquisition, so they’ve got organic distribution. Comparing across models can be challenging. Comparing within models can be very, very helpful.

David: For example, for B2B companies, efficiency with which you spend a sales dollar, whether it’s on a rep, marketing, bottom-up sales, inside sales, or outside sales, is always one of the most important things that you look at.

Navigating market uncertainty

Das: Markets are unpredictable, which is something we’re seeing now more than ever. How do you use finances to make better, faster decisions, especially in uncertain times?

Jeff: I started my career in finance. I ended up as CFO with The Disney Store, so it’s near and dear to my heart. The typical finance function is conceived of as keeping score, and the accounting control function just reporting back. For me, that was necessary, but not sufficient. The finance function has access to all the key data. I look at finance not only to keep score, but to score points and make the business better by leveraging their access to the information, trends, and unit economics to improve the business.

Caroline: A good finance leader needs to work with the CEO to make sure that the company has enough money to not just survive, but thrive. That means becoming intimately familiar with the business. Not the financial statements, not the accounting that goes into developing these things, because those just represent what’s happening at the business level. They really need to understand how everything works and then which levers you can pull or push to accomplish the things that you want in the timeframe that you need to do it, all backstopped by the cash you have on hand.

Jeff: When I was managing businesses I always had a mental model of how the business should work. That mental model typically, and ideally, was consistent with the financial model. Back when I managed eBay, the platform attracted every leading finance professional who was into micro because it was one of the most pure examples of a perfect economy. If there was an increase in supply, prices fell. If you changed the fee structure, behavior changed.

When businesses diverge from the mental model, you really need to pay attention. “Why is the conversion rate going down? My God, I’ve never seen it go down like that.” That’s a big warning indicator for me. I would typically be pretty comfortable running the business until anomalies emerged, and then I would need to understand the driver of the anomaly.

Caroline: I can’t emphasize enough how important it is for companies to understand how their bottom up generates revenue. I see a lot of people do top down forecasting. Last quarter they had $10 million in revenue. Then they go, “Historically we’ve grown 50% or 100%, so we’re going to model something similar to that for next year. That’s our number.” It’s got no intelligence built into it whatsoever. What you have to do is double click on that and go, “We made $10 million last year. How was it made? What was the makeup of that customer base? Who’s likely to still be here? Who’s going to spend more and who’s not? Who’s going to completely leave the platform?”

Jeff: In marketplaces, you often get two shots at bottom up because you typically can build a model based on supply or you can build a model based on demand. I’ll give an example from eBay: we looked at the behavior of sellers. We had this many sellers growing this fast and exhibiting this kind of behavior, and we rolled them together to come up with a revenue estimate. Then we’d sanity check it. We have this many buyers buying this frequently, spending this much, and coming onto the platform at this rate. We’d run that number and ideally the two would inform each other.

David: So one of the best CEOs I worked with was George Kurtz from CrowdStrike. He had an exceptional business. When we were working together we came to realize his gross margins were a little lower than most other software companies that we were working with. Based on that, he made the decision to experiment. In one quarter, he made gross margin part of the calculus for rep sales compensation. Over the last three years, gross margins have gone from 35% to 70%. This was a very operational and tactical decision that had a massive impact on the value of the business.

Cash is king

Das: I want to go back to a point that Jeff brought up about having a mental model of your business, hoping that the model matches the financials, and then having those red flag moments. I think a lot of companies right now are having a red flag moment because of a lot of circumstances that are beyond their control. I’d love to hear what you are telling founders right now about how they should think about their financials.

Jeff: This is one of the most significant disruptions I’ve experienced–and I’ve had a long enough career that I’ve experienced a bunch of them: the bubble burst in 1999–2000 and the financial crisis of 2008–2009. By the way, we took OpenTable public in May 2009. The future isn’t dictated, but a couple of things come to mind. One, cash is king. Throw the income statement away and just look at the cash flow statement. How much cash do you have? How’s the burn? How are you adding or using cash over time? Two, throw out your forecast. It’s now meaningless because it was based on a bunch of assumptions that no longer hold.

Throw out the financial print and start looking really hard at things like year-over-year, which typically doesn’t lie, and do tons of sensitivities. You have to do it decisively. I always liked the thought exercise of looking at the absolute worst case scenario. How bad could it get? I think people tend to do the opposite and they iterate down. We’re down 5%, so I’m going to plan to be down 10%. But if it’s going down 5% per day and you’re planning 10%, your plan is obsolete in two days. I found that it’s helpful both from a prudent cash management perspective and a mental perspective to not let this continue to erode. I’ll just get more and more depressed every day. Instead, look at reality and then try to change it.

Caroline: I agree. I was a CFO at a company called AdBrite in 2008. At first we didn’t want to believe that it could get that bad, but we were an advertising network. Unless you were Google–and even they were impacted by this–your customers weren’t going to advertise anymore. Marketing departments were decimated. There were situations where zero blog contracts that we just signed were now getting outright canceled.

We made a decision to cut really deep and as quickly as possible because we knew that even if we got it wrong, at least we would only do it once and could rebuild the company. Then we could tell employees that we made this big decision, what it was based on, and our cash position. We brought them into that circle of trust and told them what we were expecting based on the worst case scenario.

Jeff: There are potential asymmetric issues. If you underestimate how bad it’s going to get and don’t deal with the situation quickly, you could very well lose your company. If you overreact and it doesn’t end up being as bad as it could have been you might have sub-optimized your company for some period of time, but it’s alive. For me, the mistake is to underestimate the potential.

David: I want to go back to something Jeff said, which was this notion of throwing your forecasts out the window. I very much agree with that on the top line revenue. You have this whole base of costs that are under your control. Those are your operating expenses. We’ve spent a lot of time with our companies running sensitivities for the operating expense budget. What’s in operating expenses are your salespeople, your marketing people, your CFO function, your HR function, your engineers, and product. Those are all people and costs that you have as a base. What happens to that cost base in order to preserve cash under various scenarios of revenue decline? You have to manage your business on a very, very granular level.

Caroline: Companies, especially startups, staff in advance of growth, so you have to really be honest with yourself.

David: These are all very, very hard decisions. I think Caroline and Jeff, especially because you’ve been in the seat of operators during really, really trying times, you’re probably pretty diagnostic about it. It’s people’s jobs, so these decisions are not to be taken lightly.

Caroline: People are reluctant to do those layoffs, which is why there are cases where it is death by a thousand cuts. Believe me, you don’t sleep when you have to make these decisions, but when you’re running a company the number one thing is to make sure the company can make it through to the other side. I understand how difficult that can be, but you can’t kick the can down the road.

Jeff: Everyone in the organization knows that the proverbial shit has hit the fan. If the leader is unwilling to acknowledge that with the team, that creates a crisis of confidence. I always found that it’s better just to call it what it is, share it, and try to enlist the team. Do we agree with this version of reality? What do we do? Denial and trying to hide it from your team is a failing strategy.

Caroline: I understand the human psychology behind that because people don’t like to give bad news. The natural impulse is to hide those things, but these are the moments where you have to be the most transparent. Talk about why you’re doing what you’re doing, how much cash you’ve got left, and how much you want to preserve. What I find is when you bring everybody into the fold they all become part of the solution. They understand that cash is king and they’ll figure out ways to be even scrappier than they might have been otherwise.

Crisis, change, and a successful IPO

Das: Jeff, you’ve lived through some crises. Go back to a time when you were facing a crisis where things were rapidly changing and you were having to make some of these difficult decisions. What was a day like then? What were you doing, especially with regards to the financials?

Jeff: I’ve got a good one for you. In mid-2008, the board at OpenTable decided that it was time to go public. The market wasn’t good, but for a variety of internal reasons we decided we had to get the puck on the ice. We got ready for the IPO and did our bake off on a Thursday in August 2008. On Friday, we informed the 6 banks whether or not they got in on the offer. On Friday, we told Lehman they didn’t get the offer. They went out of business on Saturday. We told Merrill Lynch they got the assignment to take OpenTable public and they traded to Bank of America on Sunday.

Over that weekend, the number of people eating in fine dining restaurants in America went down by 15%. In one weekend. I walked into the Monday morning org meeting and all the bankers and lawyers were there and it was not going well. Our business is in a free fall. The bank just changed, the consumers are terrified. It was pretty clear we could not proceed with the IPO because we couldn’t predict it. Then we looked at what we could predict, so we put it on hold for 3-4 months. It turned out that consumers dined at restaurants at 85% of what they had the prior year. At that point, we got confident that the business was predictable, we restarted the process, and it ended up being a successful offering.

Das: How were you looking at the financials during that time? How did those come into play as you went through that process?

Jeff: We watched the year-over-year change in dining reservations on a daily basis–and it kept falling. We were concerned that the more nervous diners were about the economy, the more they’d stop eating out, and we’d go from a revenue of X to revenue of like 0.3 X. The business would have been hugely stressed at revenue of 0.3 X. The one key North Star metric was year-over-year diners per night, and that gave us the confidence to restart the offering.

Creating a contingency plan

Das: How does a startup or a founder approach contingency planning around their finances, especially in a high growth startup that’s going through cash quickly and been pretty aggressive with risk taking until now?

Jeff: When a shock hits the system, you want to scenario plan quickly–even if it’s bluntly. If I was running a business in this environment, I would plan for the expected outcome, a slightly better outcome, and the worst case scenario. Then build your response if each of those comes true. You put much more time into the plan than you do building the sensitivity scenarios. One of the less-productive activities is making that sensitivity beautiful and accurate and it takes two months, and then the company’s out of business. Take the bluntest assessment. David and his team have done this for a few of our internal companies.

David: We took every company’s financials and started with revenue. We said, “Let’s start with your budget and then let’s run sensitivity analyses for your revenue, assuming you hit your budget. You’re flat, you don’t grow, you declined by 25% or by 50%.” Then we compared that with a company’s operating expense budget. Assuming you don’t grow your operating expenses, if you run your current budget of operating expenses across all these different scenarios, then assume your operating expenses decline by 25% or 50%, what is your cash runway in each of those scenarios? We plugged that in for each of our companies and gave it to them. It’s a helpful way to put some parameters around what their runway is if things get really bad. It often helps them to think about a contingency plan in the event of flat revenue. If that happens, they know how much runway they have so they can take action.

Caroline: A lot of times companies are building things as the plane is in the air and they solve their problems linearly by throwing bodies at it. This is an opportunity to refactor your code base, shore up infrastructure, and build internal tools to make your teams more efficient. When you do come out the other side you are primed and ready to hit the ground running because you have built the foundation that you need to scale your business.

I worked at AdBrite before Amazon Web Services was a big thing. We had to have our own data centers, so we were a very capital-intensive business. We realized we weren’t going to be able to afford to be constantly replacing our servers. Our CTO presented this thing called AWS and said: “One, we can’t afford to upgrade our server. Two, this is probably going to improve our gross margins because we can flex up and down when we need the capacity. Can we give it a try?” AWS launched in 2006 and this was 2008, so cloud-based anything was still pretty new. We became a beta customer of theirs. When we came out of the crisis, we were a cloud-based ad serving company. We deprecated all of our data centers and moved everything to AWS.

Das: What bottom-line advice are you giving to founders right now?

Caroline: During the 2008 credit crisis when housing prices dropped 30-40%, if you interviewed people on the street who owned homes and asked them, “What do you think the US residential market has done in terms of real estate values?” Across the board they would say, “It’s down 30% to 40%.” When asked about what happened to the value of their own home, they’d say, ”It’s not down at all. It’s still fine.” No one believes that it’s going to happen to them, but it is happening to them. That is the thing that I want founders to understand. You are not going to be impacted asymmetrically compared to everybody else. It’s unlikely that you’ll be the outlier.

Jeff: We’ve offered a lot of advice on confronting reality and decisively planning for the worst case scenario. Psychologically that is pretty darn challenging on the founder. I’ve lived it. It’s incredibly important for the founder to manage their own psychology. One of the best resources I’ve read on that is Ben’s book, ‘The Hard Things about Hard Things.’ You flip from peacetime to wartime and people are looking for you to lead. You have to take the horn.

I always was most uncomfortable with my personal psyche when things were going great. When OpenTable was trading for like 21x forward revenues, which is an absurd valuation, I was jumping out of my skin. Once I confronted the fact that we were in one of those moments and I needed to lead out of it, I actually found it motivating to show what we could do. The CEO and founder needs to confront reality quickly and lead the company through to get to the other side. Things will get better again, but the biggest thing you have to actively manage is your psychology.

Das: Thank you David, Jeff, and Caroline, for joining us on the podcast today.