Note from Mashauri: this is an excellent unit to review and helps you link finance to business models.
The engine of your business is your business model. In your business model you develop your strategies and tactics for making money as a business. Learn how to convert those strategies and tactics into financials.
(Transcript below suggested viewing)
- Historical data impacts current revenue
The engine of your business is your business model. In the business model you develop your strategies and your tactics for making money as a business. Here now, what we’re going to talk about is how to convert those strategies and tactics into financials. First, a quick review of your business model. At the core of your business model is your value proposition, right? Your value proposition is what benefit do you offer to your target customers. There should be an economic analysis that says that customers receive a certain quantifiable benefit from your value proposition. Anita Newton talks about your value proposition and your positioning statement in her wonderful series on entrepreneurial marketing. The key to the success of any business is to have a competitive advantage over all the other products out there. That enables you to convince your customers to buy your product instead of a competitor’s product. They might even be willing to pay more for your product. So understanding the economics of your competitive advantage is key to things like your pricing.
The other thing you have to understand when you’re thinking about your competitive advantage is, what are we going to have to spend to keep that competitive advantage. We’re going to have to keep investing in our product, in our technology, in our people, in order to sustain that competitive advantage. What’s it cost for you to make the product, to service the product, then to sell the product, and support the product?
So the next obvious thing is your price. Your revenues are a function of your price times the number of units that you sell. Now when you think about other elements of your business model, you think about things like your marketing strategy and your sales strategy. And we think of those as, you know, strategies tactics. But all of them have a financial impact. How much are you spending on marketing? What is the return on your marketing dollars spent? What are spending you on sales. How much does it cost to acquire a customer?
So after you pull your business model together you need to translate the elements of your business model into a business model formula. Your business model formula translates your business model into financials. So for example, we sell this product or service to these target customers. The reason our customers buy our product is this compelling benefit. We have an advantage over our competition because of this sustainable competitive advantage. We will be become profitable in the inth quarter of 200X by selling so many systems or licenses or units or subscriptions, whatever it is your selling, to so many customers. We’re going to sell through these channels or partners. Or we’re going to sell directly at a price of X per system or license or customer or unit. With a cost of X dollars for each customer you acquire. At that point our revenue run rate will be X million dollars on an annualized basis.
Now we’ve been talking about your business model and your business model formula as if it’s a fixed static thing. But it isn’t. The reality is, these things are changing all the time. So the trick is for you to get out there in the marketplace, quantify what’s really going on, and bring it back and incorporate into your business model formula. So you might think initially the cost of acquiring a customer should be this. You go out to the marketplace; it turns out it takes longer, it costs more. You’ve got to bring that back, build it into your business model. The point being this is a constantly changing process.
Investors want to know that you really understand more than just the strategies and tactics of your business model. They want to know that you understand how to translate those strategies into how you make money. They are going to want to know that you have a financial understanding of the implications of everything in your business model. So for example, what is the sales cycle in your business? Are you going to be able to sell each customer in 45 days? Or 90 days? Or is it going to take a year? That has serious financial implications. Or if you’re in a consumer business, what’s the conversion rate for consumers that come to your web page? Or for consumers that click on an offer? So you need to know these financial metrics. That’s what I mean by translating your business model into a business model formula.
Acknowledgements to: Kauffman Foundation.