Metvy

Business Program
Strategy Compendium II
Financials

In this section, we will cover:

• Financials.

This is where you’ll convert the value of your offering into revenue for your business.

Company financials include revenue models- how you’ll make money, pricing- based
on the value you’ve created for your customer, sales projections- projecting your sales
over time- and investment need- how much money you’ll need to be able to grow your
business.
Let’s take a look at each one.

REVENUE MODEL:
The best revenue model will depend on your business type. The main considerations in
choosing your revenue model are:

• your customers and

• your company goals.

Remember, your customer is whoever is paying. This could be different from your
users.

For example, an app may allow users on the platform for free while charging
businesses to be able to advertise. The way to build and extract value from your
customers, the businesses, would be different from how you try to extract value from
the users. And trying to do both could mean do neither well.

Revenue model for products tend to be simple:

• You’ll either sell the product outright or

• license it to a bigger company.

Services have two main options to monetize.

• First, charging the user they’re either subscription fee or intermediation fee. This
is like when Netflix charges a monthly fee to access their service.Or when Uber
takes a percentage of the amount charged to riders.
• Or charge businesses for data or advertising-- like Yelp. This option means that
businesses are your customer, and you have to build a user base that the
customers will care about.
PRICING:
Pricing has a huge impact on your profit. This is because any raise in pricing goes
directly towards your profits it may be tempting early to have a lower price to try to get
a lot more customers but it would take a lot of customers to make the same impact on
profit as raising your price.

The main factor to consider in determining your pricing is how much value you’ve
created for your customer your quantified value proposition will be helpful here.

The value of your offering is not necessarily how much people are willing to pay. The
value customers perceive will vary for each person and will be influenced by your
marketing and your competitors.

Consider what your customers’ point of comparisons for pricing will be. It’s important
that you cover your costs, but this shouldn’t be the main consideration for your price.

To calculate how many sales you’ll need to cover costs, look at your bill of materials- the
total cost to make your product. Then determine how many sales you need to recover
the cost at different prices.

It’s also important to note that it’s easier to lower price than it is to raise price. If you’re
tempted to start with a lower price, consider instead starting with a higher price and
discounting to get to your target amount. This allows you to reflect your value while
also letting customers think they’re getting a great deal.

And remember, the early adopters are the ones with the biggest burning need and,
therefore, the highest willingness to pay.
SALES PROJECTIONS:
Sales projections will help you set goals and manage your progress. Keep in mind that
every projection for up to a year is a promise of delivery. So you should have a clear line
of sight to being able to achieve these numbers.

Don’t bother going into detail for sales forecasts over five years. Just use rough
estimates, balancing between being visionary and ambitious of your company
potential and realistic of what you can achieve.

There are two main approaches to market sizing:

• top-down and
• bottom-up.

Bottom-up is more crucial in your early years, when you need to have a high degree of
certainty of the numbers you can achieve.

While top-down is more helpful in later years, when you need to have a rough estimate.

Both are critical for every year, though, to be able to check for gaps in logic. A bottom-
up approach builds up to your market size through small assumptions of what can be
delivered, sometimes called counting noses.

This is for both the side of how many customers you’ll be able to reach, plus how much
of your product you’ll be able to produce and deliver. This will require some primary
research. So you’ll have to get out there and do some learning.

The top-down approach takes the total market and estimates your potential market
size. This can be done with some secondary research online and making assumptions
about sizes of market segments to get to your target market.

The key here is to make sure that you don’t size the market so large that you’d only be
getting less than 5%. Know your market well enough to be able to be reaching more.
Let’s look at an example.

Either is an app that allows people to crowd source fashion decisions. Their customers
are boutique clothing stores, where Either allows these businesses to learn more about
the clothing preferences of their customers.

Bottom-up market sizing.

If you estimate that in the first year, you’ll have 200 stores as customers with an
average spend of $40 each you’ll achieve $8,000 revenue in the first year. In year five,
if you have 12,000 stores as customers generating $200 in average revenue each your
revenue would be $2.4 million.

This calculation allows you to then understand the operational logistics that would
be required each year to reach your target stores and revenues, through the business
development, user acquisition, and service features.
The top-down approach helps check the five-year projections.

Since the company is targeting just small businesses and start ups, this brings us to
$100 million, since these companies account for 10% of the total spend. We should then
consider only the portion of the spend that’s on mobile advertising, bringing it to $30
million, 30% of the advertising budget.

Therefore, a revenue projection in year five of $2.4 million is reasonable, since it’s just
short of 10% of small business mobile marketing spend per year.

As Either captures more of the smaller market, they can consider growing to reach
larger businesses.

While we’re thinking about revenue models and sales projections, let’s look at a few
other aspects of finance you should know.
Gross profit. This is how much profit you have left after the direct cost of developing
your product. The direct costs are sometimes referred to as the variable cost or COGS
(the cost of goods sold). These are the only ones to include when calculating your gross
profit.

Net profit. This is the profit that remains after factoring in all costs, both the direct
costs included in gross profit, plus indirect costs, sometimes referred to as fixed costs,
such as sales and marketing, office space, or any other expenditure that’s not directly
related to developing your offering.

Break even. Your break even calculates how many customers you need to be able to
recover your initial fixed costs. It can be helpful to know this number of customers to
then get an estimate of how long it will take you to break even. Will it take months,
years?

Cost of customer acquisition. This is the average amount of money that you’ll need to
spend to acquire one individual customer. In this calculation, it’s important to include
the cost of customers that didn’t purchase. If you spend $1,000 on sales and marketing
to reach 10,000 potential customers, and 10 of them actually purchase, what’s your
cost of customer acquisition? The answer is $100. It doesn’t matter how many potential
customers you reach. It only matters how many purchased.

You want the total revenue from a customer to be at least three times your cost of
customer acquisition. This means that if it costs you $100 to acquire a customer, your
revenue per customer should be at least $300.
INVESTMENT NEED:
Your investment need will be the total amount of initial cost needed before revenues
are able to cover costs.

To determine your financial need, look at your revenues and costs over time, and
combine them into a profit projection.

The cumulative amount of negative money of the profit curve before trending
upwards reflects the total investment amount. The shape of this curve is often referred
to as the hockey stick.

This example shows the expected profit of a startup over time.

The profit each month factors in the quantity of products sold, the revenue for each
product, and the variable and fixed costs for that month.

The cumulative profit line shows that the company needs $115,000 invested before
being able to sustain itself through profits.
Let’s understand this through an example:

Financial Calculations
First, let’s determine how much Gross Profit he makes on each batch of cookies.

• One batch is 24 cookies.

• Frank starts by selling cookies for $1 each.
• It costs Frank $10 in materials to make one batch of cookies (sugar, butter,
chocolate chips, packaging, etc.)

Operational Calculations
Great! We’ve found that Frank must invest $10 in materials to gain $14 in gross
profit.Frank discovers a trade show that would be perfect for selling his cookies! He
wants to see how many cookies he’ll be able to make for the trade show, with the
following constraints:

• He can only make cookies for two days in advance of the trade show to make
sure they’re fresh.
• Each batch of cookies takes 40 minutes and he works for 8 hours per day for the
two days in advance of the show.

Breakeven Calculation
Frank is excited to bring his 24 batches of cookies (576 total cookies!) to the trade
show.

In addition to the investment in the cookie materials, it will cost Frank the following
to have a booth at the trade show:

• $200 fee for the booth

• $60 for booth signage and displays, plus business cards
• $60 for a sales person to help support him during the event
• $30 in travel for gas, tolls, and parking
Adapting
Oh no! Frank would need to sell 25 batches of cookies to recover his costs, and he
only has 24 batches. So even if he sells out ALL of the cookies, he would still take a
loss on the booth. He could see a few options here:

• Consider the event an “investment” and hope that customers will buy more in
the future - a very risky strategy that rarely pans out.
• Don’t attend the event and find other marketing channels that would have a
better payoff - certainly an option, especially if there are a lot of options that you
need to assess between.
• Play with the number to see what it would take to make the event make sense -
let’s start here!

The first thing to test with the numbers is pricing - this can have a huge impact
on your profit. Let’s say that you start charging $2 per cookie. Keeping the other
assumptions the same ($10 / batch of materials, 24 batches capacity, $350 cost of
attending the event), what do your numbers look like now?

Other Considerations
Hooray! Frank can make a profit at the trade show. Or can he? Here’s a few things
that he should consider before making the decision to attend:

• What portion of his cookies will he expect to sell? Will it change a lot based on
the price?
• Are there other costs he hasn’t considered yet? What about the cost of using the
kitchen to bake, the wear and tear on his kitchen supplies, and the value of his
own time?
As a company scales, these hidden costs need to be factored in. Let’s assume that
Frank sells all of the cookies he brings to the trade show and has a profit of $562. If
he were to pay himself for his time, or pay someone else for their time as he needs
to make more cookies than he can produce on his own, is this enough profit to
cover a reasonable rate?

If preparing for the event, cooking, and running the booth totaled 4 days of work
at 8 hours for each day, the profit distributed over these hours would result in him
being paid $17.56 per hour. If Frank would be able to hire others to make cookies at
the same rate and quality as his cookies, and for a lower rate than $17.56, he would
be able to sustain the business at the price of $2 per cookie.

Want to take your financials to the next level?

Use our financials template to start developing your financial projections.