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UNIT ECONOMICS © 2017 Rick Rasmussen
MODULE OBJECTIVES
Learn the basics of unit economics
Understand
­Unit Revenue
­Unit Costs
­Fixed Costs (overhead)
MODULE OBJECTIVES
Learn the basics of unit economics
Understand
­Unit Revenue
­Unit Costs
­Fixed Costs (overhead)
Revenues
minus Costs
equals Gross Profit
MODULE OBJECTIVES
Learn the basics of unit economics
Understand
­Unit Revenue
­Unit Costs
­Fixed Costs (overhead)
Gross Profit
minus Expenses
equals Net Profit
Revenues
minus Costs
equals Gross Profit
WHAT ARE UNIT ECONOMICS?
A microscopic view into the transactions that make up your
business
Understanding the basics of what it costs to
produce and sell one unit of goods
­One pizza
­One job done
­One client serviced
WHAT IS YOUR UNIT ?
­One new device?
­One new client using your service?
­One new subscription?
­One hour of billing time?
Figure out the Unit Economics for your business:
HOW DO YOU MAKE MONEY?
Unit Economics Gross Profits Fixed Costs
Behold the lowly clicker
Behold the lowly clicker
This is our Unit
Our wholesale price
is $16
STARTING WITH UNITS
1. Each unit has a Price
2. Each unit has a Cost
­These are your variable costs
­Also called COGS for Cost Of Goods Sold
Unit Economics Gross Profits Fixed Costs
STARTING WITH UNITS
1. Unit Price
2. Unit Cost to produce and sell
­These are your variable costs
­Also called COGS for Cost Of Goods Sold
Unit Economics Gross Profits Fixed Costs
Unit Price
minus Unit Cost
is your gross
UNIT PROFIT
OUR UNIT COST
Unit Economics Gross Profits Fixed Costs
Item Cost
Housing $1.50
Electronics + Laser $2.50
Battery $0.25
Packaging, manual $1.00
Wireless Module $1.75
Total Unit Cost $7.00
UNIT PROFIT
This is the profit you make per unit sold
Average Selling Price (ASP): $16.00
Average Unit Cost: - $7.00
Unit Profit: $9.00
Unit profit is also called gross profit or gross margin
Unit Economics Gross Profits Fixed Costs
PERCENT PROFIT MARGIN
Percent profit margin =
(Revenue – cost) / Revenue =
Profit / Revenue =
$9 / $16 = 56.25%
Is this good?
43.75%
56.25%
Revenue
Unit Costs
Unit Profits
GROSS PROFIT
We’ve sold 100K units..!!
Gross Revenue: $1,600K (same as $1,600,000)
COGS: - $700K
Gross Profit: $900K
Unit Economics Gross Profits Fixed Costs Full P&L
Notes:
1. US uses period as a
decimal point
2. Larger numbers
always expressed as
$K ($1000) or
$M ($1000K)
UNITS SOLD à GROSS PROFIT
Unit Economics Gross Profits Fixed Costs
Units Sold (K) 100K
Average Selling Price (ASP) $16
Gross Revenue ($K) $1,600
Average Cost $9
COGS ($K) $900
Gross Profit ($K) $700
Step 1
ADD IN FIXED COSTS
The costs of being in business
These generally include:
­ Salaries
­ Marketing
­ Rent, Insurance and Utilities
­ Interest payments
All stay the same whether you sell one or 1M units
Unit Economics Gross Profits Fixed Costs
WHAT ARE FIXED COSTS?
Almost all businesses have some Rent
Most B2B businesses are driven by Salary costs
Most B2C and B2B2C businesses
add Marketing and Sales as a primary expense
* Exception to both would be large factories where Capital cost considerations
need to be added
Unit Economics Gross Profits Fixed Costs
SALARIES
How many people needed to run
the business?
­Management
­Engineers
­Marketing, Sales, etc.
Unit Economics Gross Profits Fixed Costs
MARKETING
Expenses relating to promotion and selling
Can be significant for B2C and B2B2C
companies
Use 30% to 55% of revenues if you need to
build a brand
Unit Economics Gross Profits Fixed Costs
TOTAL FIXED COSTS
Add Salary, Marketing and Sales and other Fixed Expenses
Unit Economics Gross Profits Fixed Costs
Category Expense
Salaries $360K
Marketing $72K
Rent, etc $90K
Total $K $522K
WHAT ABOUT OTHER COSTS?
… It depends
Yes:
If we can attribute marketing costs on a per-unit basis
Example is a coupon redeemed for a given unit
This is a Unit Cost.
No:
If we are running a general campaign and cannot attribute to specific unit sales
These are Fixed Costs
Unit Economics Gross Profits Fixed Costs
A UNIT COST EXAMPLE
Coupons…
We run a coupon campaign for $2 off
For every unit sold with a coupon - $2 is added to the
cost of that good sold.
We can attribute the coupon to the cost of selling that
specific clicker
This is a Variable or Unit Cost.
Unit Economics Gross Profits Fixed Cost
A FIXED COST EXAMPLE
General Advertising
We run radio ads, We attend trade shows
Increases sales but can’t attribute our
expenses to any specific unit sales.
This is a Fixed Cost
Unit Economics Gross Profits Fixed Cost
This image cannot currently be displayed.
?
VARIABLE VS. FIXED COSTS
Variable Costs
Direct Materials
Direct Labor
Fixed Costs
Corporate Expenses
Rent
Salaries
Insurance
Training
Research
It Depends
Shipping, Delivery
Marketing Campaigns
Sales Commissions
Utilities
Scrap
Recalls
EXAMPLE BUSINESS MODELS
Product Business
Retail Business
Online Business
SaaS Business
B2B Direct Sales
Franchise Model
Licensing Model
Consulting
Sales Commissions
B2B2C
Donations
Not-for-Profit
Social Enterprise
Two-sided-markets
Everyone has different sets of fixed and variable costs
WHAT DO ACCOUNTING PEOPLE CALL THIS?
ALLOCATING FIXED COSTS
For tech companies, normally summarized as:
­M&S Marketing & Sales
­R&D Research & Development
­G&A General & Administrative
ZONES OF REASON
Once a company reaches “steady state”, you can
compare expenses vs. industry norms.
For tech companies, normally summarized as:
­ M&S Marketing & Sales
­ R&D Research & Development
­ G&A General & Administrative
Category Expense
Marketing 20% to 55%
R&D 10% to 30%
G&A 8% to 15%
FINAL RESULTS
Our Clicker
Business…!!!
Here is everything
lined up for one period
Are these good results?
Results %
Revenues $1,600K 100.00%
COGS $700K 43.75%
Gross Revenue $900K 56.75%
Marketing $480K 30.00%
R&D $320K 20.00%
G&A $120K 7.50%
Net Revenue $160K 12.50%
NEXT… BUILDING A P&L
Revenue minus COGS = Gross Profit
Gross Profit minus Fixed Costs = Net Profit
1. Start with assumptions
2. Build a timeline
3. Unit economics used to derive gross profits
4. Add in fixed costs / expenses
5. Construct your P&L table
Unit Economics Gross Profits Fixed Costs Full P&L
BUILDING A FINANCIAL MODEL 31
© Rick Rasmussen 2016
THE FINANCIAL MODEL
Investors don’t put their money into ideas.
They put their money into businesses…
Your financial model is your ‘real’ business plan
Revenues
Profits
Cash needs
Hiring plans
Runway
Plus a sensitivity analysis
32
PHILOSOPHY
Build your models to answer questions such as:
Is this a real business?
Can it make money?
Will it scale?
Proof Points. Show evidence and traction
Your results to date
Comparable companies in the market
Investors will test every line item
Revenues
Margins
Expenses
Cash flow
34
Cash flow positive
REVENUE TIMELINE VARIES BY MARKET TYPE…
Existing Market Re-Segmented
Market
New Market
1
2
3
4
5
6
7
1 2
3
4
5
6
7
1 2 3
4
5
6
7
BASIC FINANCIAL STATEMENTS
Income Statement: Stated over a series of reporting periods
Also referred to as a profit and loss statement (P&L)
Revenues – expenses = profits
Balance Sheet: A "snapshot of company's financial condition”
Assets = Liabilities + Owner's Equity
Cash Flow Statement: Changes in balance sheet accounts affect cash
Operations, Investment and Financing activities
INVESTORS EXPECT:
A 5-year P&L
CEO should build first one
Get to know the format and numbers intimately
Yearly in the presentation
Detailed breakdown for due diligence
Year 1-2 are Quarterly (or even monthly)
Year 3-5 are annual
INCOME STATEMENT: BASIC STRUCTURE
Revenue
- Cost of Goods Sold (Variable costs)
= Gross Profit (Rev – COGS)
Gross Profit
- Expenses (Fixed Costs)
R&D
Sales and Mktg
General and Administrative (G&A)
= Net Profit [Gross Profit - Expenses]
+/- Other Income (expense)
= Net Income
REVENUES
Work from your time line
Break out every one of your products
or services
List assumptions
Units sold per period
Estimate ASP (avg selling price)
Channels and commissions
Churn, Returns, etc.
Each company’s business model will
differ
Benchmark vs. Competition
Make sure that it passes the
“common sense” test
COMPANY TIMELINE
Q3Q1 Q2 Q7Q6 Q8
Cash
Flow Positive
Series B $7M
Started
company
MVP
Full
Production
Q9
Series A $2M
Second
prototype
Closed
Beta
1st alliance
signed
Seed $100K
Q4 Q5
Employees: 4 6 9 10 11 14 18 22 24
Q10
1M
Users
OUR EXAMPLE BUSINESS: NEWCO
Two product lines with a services component
First Product Line:
Fast growing “existing product”
Sales starting month 2
Lower margins à high COGS
Second Product Line:
Slower growing “new product”
7 month design cycle to MVP
Slow to get traction but high growth. high profit
Services business:
Scales with headcount
NEWCO SHORT-TERM REVENUE ASSUMPTIONS
Yr 1 Q1 Yr 1 Q2 Yr 1 Q3 Yr 1 Q4 Yr 2 Q1
Product 1 Units Sold 150 600 2400 9600 12000
ASP $15 $20 $25 $25 $25
Total $K $2.25 $12 $60 $240 $300
Product 2 Units Sold 25 75 100
ASP $0 $50 $75
Total $K $0 $3.75 $7.5
Services and
Maintenance
Total $K
$5 $10 $20 $40
NEWCO 5-YEAR REVENUE ASSUMPTIONS
Year 1 Year 2 Year 3 Year 4 Year 5
Product 1 K Units 12.75 50 200 500 750
ASP $24.65 $25 $20 $16 $14
$K $314 $1250 $4000 $8000 $10500
Product 2 K Units 0.1 5 25 100 1000
ASP $62 $75 $60 $50 $40
Total $K $3.75 $375 $1500 $5000 $40000
Services and
Maintenance $35 $750 $2250 $3500 $5500
Total $K $353 $2375 $7750 $16500 $56000
COST OF GOODS SOLD (COGS):
Unit economics
Variable costs change if you produce more or fewer units
Physical products: Cost of manufacture, shipping, …
Service based: Cost of services (hours)
Virtual based: Customer Acquisition Costs (CAC)
Gross Profit = Revenue – COGS
Gross Margin % = Gross Profit / Revenue
PRODUCT 1: 5-YEAR COSTS AND MARGINS
Year 1 Year 2 Year 3 Year 4 Year 5
Product 1 K Units 12.75 50 200 500 750
ASP $24.65 $25 $20 $16 $14
$K $314 $1250 $4000 $8000 $10,500
Unit Cost $20 $18 $15 $12 $10
COGS $255 $900 $3000 $6000 $7500
Gross
Profit
$59 $350 $1000 $2000 $3000
Margin % 9.8% 28.0% 25% 25% 28.6%
PRODUCT 2: 5-YEAR COSTS AND MARGINS
Year 1 Year 2 Year 3 Year 4 Year 5
Product 2 K Units 0.1 5 20 100 1000
ASP $62 $75 $60 $50 $40
Total $K $3.75 $375 $1200 $5000 $40000
Unit Cost $55 $40 $30 $22 $18
COGS $K $5.5 $200 $600 $2200 $18000
Gross
Profit $K ($1.75) $175 $600 $2800 $22000
Margin % (46.7%) 53.3% 50% 44% 45%
SERVICES: 5-YEAR COSTS AND MARGINS
Year 1 Year 2 Year 3 Year 4 Year 5
Services and
Maintenance
Gross
Income
$35 $750 $2250 $3500 $5500
COGS
$5 $25 $100 $150 $200
Gross
Profit
$30 $725 $2150 $3350 $5300
Margin % 85.7% 96.7% 95.6% 95.7% 96.4%
EXPENSES: WHERE TO START
Fixed Cost expenses occur independent of units produced
Salaries
Start with a hiring chart by dept.
Whom do you need & when
State expected salary
In the US add ~22% for payroll taxes, benefits, overhead
Major line items are listed by “department”
Research & Development (R&D) Engineering and development
Sales & Marketing Salaries, commissions, expenses
General & Administrative Management, finance, overhead, rent
HEADCOUNT: PRODUCT LINE 1 -- EXISTING PRODUCT
Dept $K Q1 Q2 Q3 Q4 Yr 2 Yr 3 Yr 4 Yr 5
Dir. Engr R&D 150 1 1 1 1 1 1 1 1
Des Engr R&D 120 1 2 2 3 3 2 1 1
Prod Engr R&D 110 1 1 2 2 3 3 3
Apps Engr R&D 100 1 2 3 3 2
Mkg S&M 100 1 1 2 2 2 2 2 1
Sales S&M 100 1 1 2 2 1 1
Support G&A 70 1 1 1 1 1
Staff G&A 50 1 1 1 1
Headcount 3 5 7 11 14 15 13 11
Salaries $K $93 $150 $200 $300 $1450 $1540 $1320 $1120
HEADCOUNT: PRODUCT LINE 2 – NEW PRODUCT
Dept $K Q1 Q2 Q3 Q4 Yr 2 Yr 3 Yr 4 Yr 5
Dir. Engr R&D 150 1 1 1 1 1 1 1
Des Engr R&D 120 1 2 2 3 3 4 6 8
Prod Engr R&D 110 1 2 2 3 3 3
Apps Engr R&D 100 1 2 3 4 5
Mkg S&M 100 1 1 1 1 2 2 2 3
Sales S&M 100 1 2 2 2 3
Support S&M 70 1 1 1 1 1
Staff G&A 50 1 1 1 1
Headcount 2 4 5 10 14 17 20 25
Salaries $K $55 $123 $150 $275 $1450 $1780 $2120 $2660
HEADCOUNT: SERVICES AND MAINTENANCE
Dept $K Q1 Q2 Q3 Q4 Yr 2 Yr 3 Yr 4 Yr 5
Dir. Svrcs S&M 120 1 1 1 1 1 1
Managers S&M 90 1 2 2 2 3
Cust Srvc S&M 60 1 2 3 3 3
Engineers R&D 80 1 1 2 2 2 3
Staff G&A 50 1 1 1 1
Headcount 2 4 8 9 9 10
Salaries $K $50 $88 $630 $690 $690 $780
HEADCOUNT: GENERAL & ADMINISTRATIVE
$K Dept Q1 Q2 Q3 Q4 Yr 2 Yr 3 Yr 4 Yr 5
CEO 150 G&A 1 1 1 1 1 1 1 1
COO 120 G&A 1 1 1 1
CFO 110 G&A 1 1 1 1
Controller 100 G&A 1 1 1 1 1 1 1
Finance 70 G&A 1 1 1 2 4 4 5 5
VP Ops 110 G&A 1 1 1 1
Operations 70 G&A 1 3 5 7 8
Staff 50 G&A 1 1 2 4 4 4
Headcount 2 3 4 6 14 18 21 22
Salary $K $55 $80 $98 $133 $1200 $1440 $1650 $1720
BUILDING OUT SALARIES
Q1 Q2 Q3 Q4 Yr 1 Yr 2 Yr 3 Yr 4 Yr 5
R & D 97 222 250 337 906 1860 2080 2300 2740
Sales & Mktg 50 50 130 194 524 1360 1420 1320 1510
G & A 55 80 98 133 366 1350 1590 1800 1870
Overhead X 1.22
R & D 119 271 305 411 1105 2269 2538 2806 3443
Sales & Mktg 61 61 195 237 639 1659 1732 1610 1842
G & A 67 98 120 162 446 1647 1940 2196 2281
Salaries 247 430 620 810 2190 5575 6210 6612 7566
NON-SALARY EXPENSES
R&D
Subcontractors and outsourced engineering
Non-depreciated tools, servers
Marketing and Sales
Trade shows
Mktg campaigns
G&A
List IP, legal, accounting expenses
Large expenses like rent, legal, travel
Either put into G&A or divide among departments as a % overhead
ADDING IN OTHER EXPENSES
Q1 Q2 Q3 Q4 Yr 2 Yr 3 Yr 4 Yr 5
Rent 2 3 4 4 20 30 40 50
Travel 1 1 2 3 20 40 50 60
Legal 10 5 8 8 40 60 80 100
Accounting 5 3 3 4 20 30 40 50
IT 5 5 5 5 20 25 30 35
Consultants 2 4 6 40 50 60 70
Marketing
Campaigns
2 8 20 20 100 100 100 100
Reserves 10 10 15 15 100 150 200 300
Total 35 37 51 65 360 485 600 765
VOILA..! NEWCO PROFIT & LOSS
Yr 1 Yr 2 Yr 3 Yr 4 Yr 5 Yr 5%
Revenues Product Line 1 $314 $1250 $4000 $8000 $10500 18.8%
Product Line 2 $4 $375 $1500 $5000 $40000 71.4%
Srvcs & Maint $35 $750 $2250 $3500 $5500 9.8%
Total Revenue $353 $2375 $7750 $16500 $56000 100%
Cost of Sales $265 $1125 $3700 $8350 $25700 45.9%
Gross Income $88 $1250 $4050 $8150 $30300 54.1%
Expenses R&D $411 2269 2538 2806 3443 6.1%
S&M $237 1659 1732 1610 1842 3.3%
G&A $162 1647 1940 2196 2281 4.1%
Other $65 360 485 600 765 1.4%
Net Income (787) (4685) (2645) 938 21969 39.2%
FINANCIAL TRAPS
Underestimating marketing and sales expenditures
­ Especially while “Crossing the Chasm”
­ Engineers: I’m speaking to you
Underestimating time to:
­ Raise money
­ Hire key personnel
­ Collect Accounts Receivable
Underestimating cash burn
FINANCIAL TEAM TIMING
Bootstrap Revenues/seed Series A/B exit
CPA
setup
You or
part-time
bookkeeper
CPA and
Attorney
Review
Full-time
Bookkeeper
or Controller
Controller
and
Part-Time
CFO
Hire
CFO
A WORD OF CAUTION
This material is not sufficient to run your
day-to-day operations
If you haven’t already…
It’s worth taking a basic accounting course
Focus on Financial Statements, Reporting, Auditing
Be Smart. Money is Important..!

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EIA2017Portugal - Rick Rasmussen - Unit Economics

  • 1. UNIT ECONOMICS © 2017 Rick Rasmussen
  • 2. MODULE OBJECTIVES Learn the basics of unit economics Understand ­Unit Revenue ­Unit Costs ­Fixed Costs (overhead)
  • 3. MODULE OBJECTIVES Learn the basics of unit economics Understand ­Unit Revenue ­Unit Costs ­Fixed Costs (overhead) Revenues minus Costs equals Gross Profit
  • 4. MODULE OBJECTIVES Learn the basics of unit economics Understand ­Unit Revenue ­Unit Costs ­Fixed Costs (overhead) Gross Profit minus Expenses equals Net Profit Revenues minus Costs equals Gross Profit
  • 5. WHAT ARE UNIT ECONOMICS? A microscopic view into the transactions that make up your business Understanding the basics of what it costs to produce and sell one unit of goods ­One pizza ­One job done ­One client serviced
  • 6. WHAT IS YOUR UNIT ? ­One new device? ­One new client using your service? ­One new subscription? ­One hour of billing time? Figure out the Unit Economics for your business: HOW DO YOU MAKE MONEY? Unit Economics Gross Profits Fixed Costs
  • 8. Behold the lowly clicker This is our Unit Our wholesale price is $16
  • 9. STARTING WITH UNITS 1. Each unit has a Price 2. Each unit has a Cost ­These are your variable costs ­Also called COGS for Cost Of Goods Sold Unit Economics Gross Profits Fixed Costs
  • 10. STARTING WITH UNITS 1. Unit Price 2. Unit Cost to produce and sell ­These are your variable costs ­Also called COGS for Cost Of Goods Sold Unit Economics Gross Profits Fixed Costs Unit Price minus Unit Cost is your gross UNIT PROFIT
  • 11. OUR UNIT COST Unit Economics Gross Profits Fixed Costs Item Cost Housing $1.50 Electronics + Laser $2.50 Battery $0.25 Packaging, manual $1.00 Wireless Module $1.75 Total Unit Cost $7.00
  • 12. UNIT PROFIT This is the profit you make per unit sold Average Selling Price (ASP): $16.00 Average Unit Cost: - $7.00 Unit Profit: $9.00 Unit profit is also called gross profit or gross margin Unit Economics Gross Profits Fixed Costs
  • 13. PERCENT PROFIT MARGIN Percent profit margin = (Revenue – cost) / Revenue = Profit / Revenue = $9 / $16 = 56.25% Is this good? 43.75% 56.25% Revenue Unit Costs Unit Profits
  • 14. GROSS PROFIT We’ve sold 100K units..!! Gross Revenue: $1,600K (same as $1,600,000) COGS: - $700K Gross Profit: $900K Unit Economics Gross Profits Fixed Costs Full P&L Notes: 1. US uses period as a decimal point 2. Larger numbers always expressed as $K ($1000) or $M ($1000K)
  • 15. UNITS SOLD à GROSS PROFIT Unit Economics Gross Profits Fixed Costs Units Sold (K) 100K Average Selling Price (ASP) $16 Gross Revenue ($K) $1,600 Average Cost $9 COGS ($K) $900 Gross Profit ($K) $700 Step 1
  • 16. ADD IN FIXED COSTS The costs of being in business These generally include: ­ Salaries ­ Marketing ­ Rent, Insurance and Utilities ­ Interest payments All stay the same whether you sell one or 1M units Unit Economics Gross Profits Fixed Costs
  • 17. WHAT ARE FIXED COSTS? Almost all businesses have some Rent Most B2B businesses are driven by Salary costs Most B2C and B2B2C businesses add Marketing and Sales as a primary expense * Exception to both would be large factories where Capital cost considerations need to be added Unit Economics Gross Profits Fixed Costs
  • 18. SALARIES How many people needed to run the business? ­Management ­Engineers ­Marketing, Sales, etc. Unit Economics Gross Profits Fixed Costs
  • 19. MARKETING Expenses relating to promotion and selling Can be significant for B2C and B2B2C companies Use 30% to 55% of revenues if you need to build a brand Unit Economics Gross Profits Fixed Costs
  • 20. TOTAL FIXED COSTS Add Salary, Marketing and Sales and other Fixed Expenses Unit Economics Gross Profits Fixed Costs Category Expense Salaries $360K Marketing $72K Rent, etc $90K Total $K $522K
  • 21. WHAT ABOUT OTHER COSTS? … It depends Yes: If we can attribute marketing costs on a per-unit basis Example is a coupon redeemed for a given unit This is a Unit Cost. No: If we are running a general campaign and cannot attribute to specific unit sales These are Fixed Costs Unit Economics Gross Profits Fixed Costs
  • 22. A UNIT COST EXAMPLE Coupons… We run a coupon campaign for $2 off For every unit sold with a coupon - $2 is added to the cost of that good sold. We can attribute the coupon to the cost of selling that specific clicker This is a Variable or Unit Cost. Unit Economics Gross Profits Fixed Cost
  • 23. A FIXED COST EXAMPLE General Advertising We run radio ads, We attend trade shows Increases sales but can’t attribute our expenses to any specific unit sales. This is a Fixed Cost Unit Economics Gross Profits Fixed Cost This image cannot currently be displayed. ?
  • 24. VARIABLE VS. FIXED COSTS Variable Costs Direct Materials Direct Labor Fixed Costs Corporate Expenses Rent Salaries Insurance Training Research It Depends Shipping, Delivery Marketing Campaigns Sales Commissions Utilities Scrap Recalls
  • 25. EXAMPLE BUSINESS MODELS Product Business Retail Business Online Business SaaS Business B2B Direct Sales Franchise Model Licensing Model Consulting Sales Commissions B2B2C Donations Not-for-Profit Social Enterprise Two-sided-markets Everyone has different sets of fixed and variable costs
  • 26. WHAT DO ACCOUNTING PEOPLE CALL THIS?
  • 27. ALLOCATING FIXED COSTS For tech companies, normally summarized as: ­M&S Marketing & Sales ­R&D Research & Development ­G&A General & Administrative
  • 28. ZONES OF REASON Once a company reaches “steady state”, you can compare expenses vs. industry norms. For tech companies, normally summarized as: ­ M&S Marketing & Sales ­ R&D Research & Development ­ G&A General & Administrative Category Expense Marketing 20% to 55% R&D 10% to 30% G&A 8% to 15%
  • 29. FINAL RESULTS Our Clicker Business…!!! Here is everything lined up for one period Are these good results? Results % Revenues $1,600K 100.00% COGS $700K 43.75% Gross Revenue $900K 56.75% Marketing $480K 30.00% R&D $320K 20.00% G&A $120K 7.50% Net Revenue $160K 12.50%
  • 30. NEXT… BUILDING A P&L Revenue minus COGS = Gross Profit Gross Profit minus Fixed Costs = Net Profit 1. Start with assumptions 2. Build a timeline 3. Unit economics used to derive gross profits 4. Add in fixed costs / expenses 5. Construct your P&L table Unit Economics Gross Profits Fixed Costs Full P&L
  • 31. BUILDING A FINANCIAL MODEL 31 © Rick Rasmussen 2016
  • 32. THE FINANCIAL MODEL Investors don’t put their money into ideas. They put their money into businesses… Your financial model is your ‘real’ business plan Revenues Profits Cash needs Hiring plans Runway Plus a sensitivity analysis 32
  • 33. PHILOSOPHY Build your models to answer questions such as: Is this a real business? Can it make money? Will it scale? Proof Points. Show evidence and traction Your results to date Comparable companies in the market Investors will test every line item Revenues Margins Expenses Cash flow
  • 35. REVENUE TIMELINE VARIES BY MARKET TYPE… Existing Market Re-Segmented Market New Market 1 2 3 4 5 6 7 1 2 3 4 5 6 7 1 2 3 4 5 6 7
  • 36. BASIC FINANCIAL STATEMENTS Income Statement: Stated over a series of reporting periods Also referred to as a profit and loss statement (P&L) Revenues – expenses = profits Balance Sheet: A "snapshot of company's financial condition” Assets = Liabilities + Owner's Equity Cash Flow Statement: Changes in balance sheet accounts affect cash Operations, Investment and Financing activities
  • 37. INVESTORS EXPECT: A 5-year P&L CEO should build first one Get to know the format and numbers intimately Yearly in the presentation Detailed breakdown for due diligence Year 1-2 are Quarterly (or even monthly) Year 3-5 are annual
  • 38. INCOME STATEMENT: BASIC STRUCTURE Revenue - Cost of Goods Sold (Variable costs) = Gross Profit (Rev – COGS) Gross Profit - Expenses (Fixed Costs) R&D Sales and Mktg General and Administrative (G&A) = Net Profit [Gross Profit - Expenses] +/- Other Income (expense) = Net Income
  • 39. REVENUES Work from your time line Break out every one of your products or services List assumptions Units sold per period Estimate ASP (avg selling price) Channels and commissions Churn, Returns, etc. Each company’s business model will differ Benchmark vs. Competition Make sure that it passes the “common sense” test
  • 40. COMPANY TIMELINE Q3Q1 Q2 Q7Q6 Q8 Cash Flow Positive Series B $7M Started company MVP Full Production Q9 Series A $2M Second prototype Closed Beta 1st alliance signed Seed $100K Q4 Q5 Employees: 4 6 9 10 11 14 18 22 24 Q10 1M Users
  • 41. OUR EXAMPLE BUSINESS: NEWCO Two product lines with a services component First Product Line: Fast growing “existing product” Sales starting month 2 Lower margins à high COGS Second Product Line: Slower growing “new product” 7 month design cycle to MVP Slow to get traction but high growth. high profit Services business: Scales with headcount
  • 42. NEWCO SHORT-TERM REVENUE ASSUMPTIONS Yr 1 Q1 Yr 1 Q2 Yr 1 Q3 Yr 1 Q4 Yr 2 Q1 Product 1 Units Sold 150 600 2400 9600 12000 ASP $15 $20 $25 $25 $25 Total $K $2.25 $12 $60 $240 $300 Product 2 Units Sold 25 75 100 ASP $0 $50 $75 Total $K $0 $3.75 $7.5 Services and Maintenance Total $K $5 $10 $20 $40
  • 43. NEWCO 5-YEAR REVENUE ASSUMPTIONS Year 1 Year 2 Year 3 Year 4 Year 5 Product 1 K Units 12.75 50 200 500 750 ASP $24.65 $25 $20 $16 $14 $K $314 $1250 $4000 $8000 $10500 Product 2 K Units 0.1 5 25 100 1000 ASP $62 $75 $60 $50 $40 Total $K $3.75 $375 $1500 $5000 $40000 Services and Maintenance $35 $750 $2250 $3500 $5500 Total $K $353 $2375 $7750 $16500 $56000
  • 44. COST OF GOODS SOLD (COGS): Unit economics Variable costs change if you produce more or fewer units Physical products: Cost of manufacture, shipping, … Service based: Cost of services (hours) Virtual based: Customer Acquisition Costs (CAC) Gross Profit = Revenue – COGS Gross Margin % = Gross Profit / Revenue
  • 45. PRODUCT 1: 5-YEAR COSTS AND MARGINS Year 1 Year 2 Year 3 Year 4 Year 5 Product 1 K Units 12.75 50 200 500 750 ASP $24.65 $25 $20 $16 $14 $K $314 $1250 $4000 $8000 $10,500 Unit Cost $20 $18 $15 $12 $10 COGS $255 $900 $3000 $6000 $7500 Gross Profit $59 $350 $1000 $2000 $3000 Margin % 9.8% 28.0% 25% 25% 28.6%
  • 46. PRODUCT 2: 5-YEAR COSTS AND MARGINS Year 1 Year 2 Year 3 Year 4 Year 5 Product 2 K Units 0.1 5 20 100 1000 ASP $62 $75 $60 $50 $40 Total $K $3.75 $375 $1200 $5000 $40000 Unit Cost $55 $40 $30 $22 $18 COGS $K $5.5 $200 $600 $2200 $18000 Gross Profit $K ($1.75) $175 $600 $2800 $22000 Margin % (46.7%) 53.3% 50% 44% 45%
  • 47. SERVICES: 5-YEAR COSTS AND MARGINS Year 1 Year 2 Year 3 Year 4 Year 5 Services and Maintenance Gross Income $35 $750 $2250 $3500 $5500 COGS $5 $25 $100 $150 $200 Gross Profit $30 $725 $2150 $3350 $5300 Margin % 85.7% 96.7% 95.6% 95.7% 96.4%
  • 48. EXPENSES: WHERE TO START Fixed Cost expenses occur independent of units produced Salaries Start with a hiring chart by dept. Whom do you need & when State expected salary In the US add ~22% for payroll taxes, benefits, overhead Major line items are listed by “department” Research & Development (R&D) Engineering and development Sales & Marketing Salaries, commissions, expenses General & Administrative Management, finance, overhead, rent
  • 49. HEADCOUNT: PRODUCT LINE 1 -- EXISTING PRODUCT Dept $K Q1 Q2 Q3 Q4 Yr 2 Yr 3 Yr 4 Yr 5 Dir. Engr R&D 150 1 1 1 1 1 1 1 1 Des Engr R&D 120 1 2 2 3 3 2 1 1 Prod Engr R&D 110 1 1 2 2 3 3 3 Apps Engr R&D 100 1 2 3 3 2 Mkg S&M 100 1 1 2 2 2 2 2 1 Sales S&M 100 1 1 2 2 1 1 Support G&A 70 1 1 1 1 1 Staff G&A 50 1 1 1 1 Headcount 3 5 7 11 14 15 13 11 Salaries $K $93 $150 $200 $300 $1450 $1540 $1320 $1120
  • 50. HEADCOUNT: PRODUCT LINE 2 – NEW PRODUCT Dept $K Q1 Q2 Q3 Q4 Yr 2 Yr 3 Yr 4 Yr 5 Dir. Engr R&D 150 1 1 1 1 1 1 1 Des Engr R&D 120 1 2 2 3 3 4 6 8 Prod Engr R&D 110 1 2 2 3 3 3 Apps Engr R&D 100 1 2 3 4 5 Mkg S&M 100 1 1 1 1 2 2 2 3 Sales S&M 100 1 2 2 2 3 Support S&M 70 1 1 1 1 1 Staff G&A 50 1 1 1 1 Headcount 2 4 5 10 14 17 20 25 Salaries $K $55 $123 $150 $275 $1450 $1780 $2120 $2660
  • 51. HEADCOUNT: SERVICES AND MAINTENANCE Dept $K Q1 Q2 Q3 Q4 Yr 2 Yr 3 Yr 4 Yr 5 Dir. Svrcs S&M 120 1 1 1 1 1 1 Managers S&M 90 1 2 2 2 3 Cust Srvc S&M 60 1 2 3 3 3 Engineers R&D 80 1 1 2 2 2 3 Staff G&A 50 1 1 1 1 Headcount 2 4 8 9 9 10 Salaries $K $50 $88 $630 $690 $690 $780
  • 52. HEADCOUNT: GENERAL & ADMINISTRATIVE $K Dept Q1 Q2 Q3 Q4 Yr 2 Yr 3 Yr 4 Yr 5 CEO 150 G&A 1 1 1 1 1 1 1 1 COO 120 G&A 1 1 1 1 CFO 110 G&A 1 1 1 1 Controller 100 G&A 1 1 1 1 1 1 1 Finance 70 G&A 1 1 1 2 4 4 5 5 VP Ops 110 G&A 1 1 1 1 Operations 70 G&A 1 3 5 7 8 Staff 50 G&A 1 1 2 4 4 4 Headcount 2 3 4 6 14 18 21 22 Salary $K $55 $80 $98 $133 $1200 $1440 $1650 $1720
  • 53. BUILDING OUT SALARIES Q1 Q2 Q3 Q4 Yr 1 Yr 2 Yr 3 Yr 4 Yr 5 R & D 97 222 250 337 906 1860 2080 2300 2740 Sales & Mktg 50 50 130 194 524 1360 1420 1320 1510 G & A 55 80 98 133 366 1350 1590 1800 1870 Overhead X 1.22 R & D 119 271 305 411 1105 2269 2538 2806 3443 Sales & Mktg 61 61 195 237 639 1659 1732 1610 1842 G & A 67 98 120 162 446 1647 1940 2196 2281 Salaries 247 430 620 810 2190 5575 6210 6612 7566
  • 54. NON-SALARY EXPENSES R&D Subcontractors and outsourced engineering Non-depreciated tools, servers Marketing and Sales Trade shows Mktg campaigns G&A List IP, legal, accounting expenses Large expenses like rent, legal, travel Either put into G&A or divide among departments as a % overhead
  • 55. ADDING IN OTHER EXPENSES Q1 Q2 Q3 Q4 Yr 2 Yr 3 Yr 4 Yr 5 Rent 2 3 4 4 20 30 40 50 Travel 1 1 2 3 20 40 50 60 Legal 10 5 8 8 40 60 80 100 Accounting 5 3 3 4 20 30 40 50 IT 5 5 5 5 20 25 30 35 Consultants 2 4 6 40 50 60 70 Marketing Campaigns 2 8 20 20 100 100 100 100 Reserves 10 10 15 15 100 150 200 300 Total 35 37 51 65 360 485 600 765
  • 56. VOILA..! NEWCO PROFIT & LOSS Yr 1 Yr 2 Yr 3 Yr 4 Yr 5 Yr 5% Revenues Product Line 1 $314 $1250 $4000 $8000 $10500 18.8% Product Line 2 $4 $375 $1500 $5000 $40000 71.4% Srvcs & Maint $35 $750 $2250 $3500 $5500 9.8% Total Revenue $353 $2375 $7750 $16500 $56000 100% Cost of Sales $265 $1125 $3700 $8350 $25700 45.9% Gross Income $88 $1250 $4050 $8150 $30300 54.1% Expenses R&D $411 2269 2538 2806 3443 6.1% S&M $237 1659 1732 1610 1842 3.3% G&A $162 1647 1940 2196 2281 4.1% Other $65 360 485 600 765 1.4% Net Income (787) (4685) (2645) 938 21969 39.2%
  • 57. FINANCIAL TRAPS Underestimating marketing and sales expenditures ­ Especially while “Crossing the Chasm” ­ Engineers: I’m speaking to you Underestimating time to: ­ Raise money ­ Hire key personnel ­ Collect Accounts Receivable Underestimating cash burn
  • 58. FINANCIAL TEAM TIMING Bootstrap Revenues/seed Series A/B exit CPA setup You or part-time bookkeeper CPA and Attorney Review Full-time Bookkeeper or Controller Controller and Part-Time CFO Hire CFO
  • 59. A WORD OF CAUTION This material is not sufficient to run your day-to-day operations If you haven’t already… It’s worth taking a basic accounting course Focus on Financial Statements, Reporting, Auditing Be Smart. Money is Important..!