Model behavior; Raising money: Abstract number sorcery won’t cut it anymore. Investors want to know exactly how you’re going to make money - Money - business models
August 19th, 2007 by moniesBut today, huge opportunity and market share are no longer enough to secure a funding deal for your growing firm. Raising money has taken a turn back to the basics. And as company earnings have come back in line with the mainstream, the real numbers game for your deal is now focused on the most elementary component in your enterprise: your business model.
“Our initial test of any investment has to do with the validity and strength of the business model and how the management team’s core experience can be used in the execution of that model,” says Jeff Carmody, a bridge loan specialist with Santa Barbara, California-based Agility Capital.
Details, Details
Your business model describes how your business goes from preparing your product or service to delivering it to your users, and how many of those transactions you need to execute to keep up with your operating costs.
You must include these details when creating or reformulating your business model:
1. Suppliers and the average price of your company’s goods
2. Labor costs per each unit your company produces
3. Selling price and the resulting gross profit margin
4. The amount your business needs to ship weekly to break even
5. Your company’s annual output and the break-even point as a percentage of total capacity
A strong business model identifies who is buying your product or service and why they choose to do business with you as opposed to your competitors. It then offers a clear rationale for why buyers will pay the price you’re charging (say, $50 per unit).
Once you give solid reasons for the buying decision, you need to report how many sales per day you make. If you say daily sales activity averages 250 customers (5,000 each month), then the revenue component of your model at $50 per unit is $12,500 each day. This metric has to make sense with respect to the scale and scope of your operation.
Next, you clarify your labor and materials costs in relation to your expenses. Perhaps your labor and materials costs for each sale are $28, leaving you with $22 per sale in gross profit, a 44 percent margin. If your overhead is $85,000 a month, that $22 profit margin needs to happen about 3,860 times every 30 days to break even with your fixed monthly costs. So the model now rests on whether you have the capability to do that kind of volume. If so, you have a sustainable business model where the first 3,860 customers each month cover all your costs, and the next 1,140 contribute $22 each ($25,000) to your pretax profit.
Take a look at this example of a poorly-thought-out business model: You have a “cool idea” that costs $60 in labor and materials to manufacture, and overhead runs $100,000 per month. You might believe a price of $75 will draw potential buyers, but with a $15 profit margin, you’ll need to sell nearly 6,700 units every 30 Days–and right now you’re doing business at an average rate of less than 125 customers per day. These metrics don’t work.
Or maybe you project a price of $100 (a 40 percent margin), which would drop your monthly volume point to 2,500 units. The problem is, there’s no way to sustain that price-point given the competitive environment. In both these cases, the numbers don’t add up, and the business model is not sustainable. There are many cases where entrepreneurs have come up with poor business models where the volume needed to cover monthly fixed costs would have to be 75 percent of the overall market share. Again, that scenario is unreasonable, and investors wont support it.
Where the Money Is
Author: David Newton
Posted in Uncategorized |