Financial modeling for startups

Business models, PnLs - for startups http://www.ﬂickr.com/photos/kidswithcourage/4588175282/sizes/o/(cc) BY NC SA, Rodrigo SEPULVEDA SCHULZ - www.rodrigosepulveda.com - May 2011

Summary• Business models• Generic PnL• Key insights (think KPI!)

1. Business models

Revenue = Price x Qty x3

R = R1 + R2 + ... = P1 x Q1 + P2 x Q2 + ...

~ ~let’s simplify with : R = P x Q

~ ~let’s simplify with : R = P x Q - are you a VOLUME business ?

~ ~let’s simplify with : R = P x Q - are you a VOLUME business ? - are you a PRICE based business ?

Volume business (usually low margin)

Price-based business (usually high margin)

the famous ‘demand curve’ P 10€ 5€ 2€ Q 100 200 500

the famous ‘demand curve’ P 10€ R = 10€ x 100 = 1.000€ 5€ 2€ Q 100 200 500

the famous ‘demand curve’ P 10€ R = 10€ x 100 = 1.000€ R’ = 5€ x 200 = 1.000€ 5€ 2€ Q 100 200 500

the famous ‘demand curve’ P 10€ R = 10€ x 100 = 1.000€ R’ = 5€ x 200 = 1.000€ 5€ R” = 2€ x 500 = 1.000€ 2€ Q 100 200 500

can you be a volume + price based business?

shift the ‘demand curve’ - hard, requires a uniquevalue proposition sustained by heavy marketing P 10€ 5€ 2€ Q 100 200 500

shift the ‘demand curve’ - hard, requires a uniquevalue proposition sustained by heavy marketing P R = 10€ x 500 = 5.000€ 10€ (5x) 5€ 2€ Q 100 200 500

Read more: http://www.amazon.com/Microeconomics-7th-Robert-Pindyck/dp/0132080230/ref=sr_1_1?ie=UTF8&qid=1304956318&sr=8-1

Costs = Variable Costs x Qty + Fixed Costs

Variable Costs : anything that can be directlycorrelated with ONE extra sale of product/service• COGS : Cost of Good Sold = Cost of Revenue• usually the cost of raw materials necessary to produce a new product, or the cost of original item if re-selling• add to that anything that can be linked directly: • commission on each sale; % fee on bank; average shipping & handling cost (if not added)...• remember to think in AVERAGE terms

Fixed Costs (standardized) -main goal is to make them variable• Sales & marketing (S&M)• Product / R&D / Technology• HR : can be factored almost into Product, S&M, G&A• General & Administration (G&A) : rent, lawyers, travel & expenses...

Margin = Revenue - Costs•M=R-C• M = ( average Price x Q ) - ( fixed costs + variable cost x Q)• M = (average price - variable cost) x Q - fixed costs• M = (Unit margin) x Q - FC

focusing on unit margin gives you great insights• M = (Unit margin) x Q - FC means • M > 0 only if • unit margin is > 0 • (Unit margin x Q) > fixed costs

focusing on unit margin gives you great insights• M = (Unit margin) x Q - FC means • M > 0 only if • unit margin is > 0 • (Unit margin x Q) > fixed costs can you keep your fixed costs low ?

focusing on unit margin gives you great insights• M = (Unit margin) x Q - FC means • M > 0 only if • unit margin is > 0 • (Unit margin x Q) > fixed costs are you a can you keepprice based your fixed business ? costs low ?

focusing on unit margin gives you great insights• M = (Unit margin) x Q - FC means • M > 0 only if • unit margin is > 0 • (Unit margin x Q) > fixed costs are you a are you a can you keepprice based volume based your fixed business ? business ? costs low ?

2. Generic PnL

startup finance is like wartime medicine :ugly but works http://www.olive-drab.com/od_medical_www.php

Let’s start a T-shirt business !

Samplecompany in this space

Sales: remember to focus on UNITS• let’s be competitive, and check prices from competition (sales- minus approach, vs. cost-plus approach).• Let’s build a business plan on a 14,99€ average price point for T-shirts• We can expand into segmentation of products, of prices, etc. later.

Sales : let’s assume I sell a few first per day, thenstart increasing sales• Assumptions : • 4 T-shirts sold per day • biz open online 24/7 = 30 days /month => 120 T-shirts/month • 5% growth / month, but decreasing slowly to adjust for linear growth • average price: 14,99€ (incl. VAT !) (19.6% in France means 12,53€ excl. VAT) - checked with market price/competition

let’s first model Revenue - you can play with variables later:such as discounts, promotions, and ﬂuctuating demand per season

2. COGS (direct costs)• let’s assume a white T-shirt bought online from a supplier• look for economies of scale• don’t forget S&H (incl. here)• your business plan should be VAT-free. Don’t add it, only for Cash-Flow statements• Make sure you order with enough lead-time (1 month?)

let’s now model direct costs - you can play with variables later : white T-shirts + stickers + shippingGross margin has to quickly become >0, >50% is best

3. Indirect costs• assumptions (t0 = launch of site, add as much HR+G&A for research before) • sales & marketing : only Google Adwords SEM (assuming cost based on conversion rates) + a launch budget for display (3 months). • technology : using a hosted solution to start with :12€/month http://commander.1and1.fr/xml/order/Eshops • HR : based on number of people to prepare and ship T-shirts + founder (finance, marketing, etc.) - everything else outsourced (incl. as costs) • G&A : rent, insurance, pro services, etc. assuming a fixed cost : rent as soon as a hire (300€/person), accountants, phone bills, etc.

last, let’s model indirect costs - you can play with variableslater :

Now that your model is built : check for errors use ‘track depencies’ to check formulas I always use YELLOW for variables - check them for likeliness often use italic to indicate a result of a formula graphing an excel row (variable or result) makes it easier to check validity checking per period (quarter, year) is useful + % salesps: beware of the last column of a model (doesn’t take into account the next period)

good practices• Put the hypothesis on each month (eg. growth) : it’s then very easy to adjust for seasonal fluctuation, or acceleration of growth rate• Always good to put reality checks in the excel sheet. you can always hide them later. I put them in italic.• always good to number each sections item, makes it very readable• make sure you document every important cell or formula• it’s best to put assumptions in a separate sheet afterwards.

Read more: http://www.amazon.com/Financial-Modeling-Simon-Benninga/dp/0262026287/ref=sr_1_1?s=books&ie=UTF8&qid=1304957285&sr=1-1

3. Key Insights (KPIs)

Break down analysis as %sales / year (~ per unit) Helps understand breakdown of costs, and efficiency potential

Graphs (and values) show profit >0 ~ month 35...

Changing variables allows to tweak & adjust business model Just changing price from 14,99€ to 18,99€ brings profitability at ~month 24 (1 year ahead). Volume to be adjusted. will the offer be competitive and attractive? Changing sales volume from 4/day to10/day brings profitability at ~month 23 (1 year ahead). Price to be adjusted + marketing expenditure. Can you validate conversion rates early enough, hence marketing expenses and traction of offer ?

Summary 1 : building a business model• Build a model of your business : the algorithm first, with all relevant variables• Make your spreadsheet easily readable, commented, well formatted : you’ll use it to fine-tune your business, and to share with investors later on• Don’t forget to double-check in all possible ways for errors• Then, check that your variables are in a realistic range• Finally, and only then, start testing different scenarios by just changing one or two variables.

Summary 2: key insights• Breakdown in 100% of revenue of ONE unit of sales• When are you profitable ? (in months?)• How many units do you need to sell to be profitable ?• Elasticity of variables (impact of each on target objective; examples = profitability, market share, revenue milestone, etc.)• In upcoming class on fundraising : helps assess how much money you need to raise

www.rodrigosepulveda.com

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Financial modeling for startups

by Rodrigo SEPULVEDA SCHULZ on May 09, 2011

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Financial modeling for startups — Presentation Transcript