An Entrepreneur's Perspective on Revenue, Cost and Profits
• Why Would I Be Interested in Doing this Session • Life Source of Your Business (Cash Flow) • Mechanics of Making Money (System and Elements) • What do Investors (Angel and VCs) Expect • Pulse of a Successful Business (Metrics)
Who is Charles Kwon
• 25+ years as Entrepreneur
Sample Companies Their Business
DSP Dev Corp Ixthos Neodesic NanoInk Extenprise Latel Advaxis MedRed LidoPatch Digital Signal processing software Industrial PC Boards Community and Knowledge Portal Nano technology applications SaaS Supply-chain and POS system VoIP Phone Company Cancer Vaccine Medical Decision Support SW OTC Lidocaine Pain Patch
Founder Founder, CMO Founder, CEO CBO CEO Founder, BoD, Investor Investor BoD, Investor BoD, Investor
• Also Head of Strategy of a F1000 Company and Partner in a Management Consulting Firm • Not a CFO or any accounting firm experience!
Why would I be Interested in doing this session?
• I want to make understanding revenues, cost and profits integral to how you think about and live your business… • …NOT just a way to do your Financials for your business plan – to raise money • That is why I wanted you to see a different perspective on this topic
Life Source of Your Business
• A financial plan shows how you plan to make money using the language of cash flow. • I will discuss this from the perspective of the non-financial entrepreneur. • First thing to understand is that cash flow IS the life source of the business (like water to a human, a business will not last long without positive cash flow)!
Mechanics of Making Money
The financial model shows you, your team and investors how you plan to make money and ultimately create wealth for all!
3) How much cash will it generate over time and will the sales and margins scale up over time?
1) What will customer pay for it and how much does it cost to make it?
2) How much will it cost and how long will it take to sell it AND will it cover the cost of sales and running the business?
4) How does all that cash flow translate into wealth creation?
Definition of Terms
• Gross Margin – Realized Price minus Cost of Goods • Contribution Margin - Realized Price minus Variable Cost • Cost of Goods – Total Cost of Product (Both Fixed and Variable) • Fixed Cost – building, equipment – portion allocated to each product • Variable Cost – labor, parts, utility – actual cost per unit • SG&A Expense – Sales, General and Administrative Expense – NOT tied to product manufacturing • EBITDA – Earning Before Interest Tax, Depreciation and Amortization (Basically Cash Flow)
1) Products Got to Make Money
Product and Service Margin
• • Making money is the difference between the price and the cost = margin There are two types of margin – gross margin (GM) and contribution margin (CM). GM is CF based on total cost, CM based on variable cost focuses on the incremental cash needed to produce the product/service (fixed cost already paid for) • There are two types of costs – fixed cost (FC) and variable cost (VC). FC is the building and equipment or other high investment costs you allocate, VC is the incremental labor, parts or utility costs per product. • • • • •
When we were developing Ixthos (computer board company) business plan, we needed very high end manufacturing equipment to manufacture the boards The (fixed) cost of the equipment would have doubled our funding (cash flow) needs We decided to find another company that had the equipment and “rented” space This reduced our C-F needs by 50% Other similar ideas: SaaS subscription, Financing, sub-let space, etc.
2) Selling it! AND Running the Business
• (Period) Expense – The cost of running the business (your salary, your exec team, and the sales staff). Typically known as SG&A (Sales, General and Administrative Cost) • This gets paid whether the product gets made OR not – month to month, hence “period” expense • Also on the Sales side – need to take into consideration how long it takes for a new salesman to sell their quota – most can take 6-9 month before first sale and 12-18 months before they are fully producing (all C-F OUT before C-F IN) • • •
Extenprise (POS and Supply Chain SaaS company) was getting repositioned into a multi-billion market – strong interest and market However, because this was a New product to New customer (New / New) – it required 2-3 more time (and C-F) to build the reference base and sell into new customers My experience tells me that New / New opportunities can be huge – but risky! Plan for ways to extend C-F
2b) New New Business is very risky – all my failures were in that space
3) Scaling Up a Business
Scaling UP C-F Model and Analysis
• Scaling up a profitable business can be tricky, especially when you are encountering high growth. • Key reasons are due to cash you need to buy parts to make the product, pay for sales staff before they are producing, and typically 30-60 days before you get paid by the customer • • As you experience 100%+ growth, you will be spending cash faster than getting cash Modeling Cash Flow and doing Scenarios can help to see what levers you have – e.g. factoring to get money faster, delaying payments to suppliers, timing sales staff onboarding, etc. • • • • •
Although, Ixthos computer boards had high margins (2x performance, 50% cost) and high revenue growth we were rapidly running out of cash We had already used factoring, delayed payments, managed sales staff onboarding, etc. We either had to raise more money (but due to medium sized market opportunity, the premoney valuation was not high – more on that later) Or sell the company to a competitor. When we ran the analysis, due to dilution from raising more money, selling was better We sold the company and provided a >10x return for the investors (this was pre-internet days)
4) Cash Flow + Growth = Value
C-F and Enterprise Value
• • When you Value a Company it is all about Cash Flow (today and in the future). The key metric for C-F is EBITDA (Earnings Before Interest, Tax, Depreciation and Amortization) – basically free cash flow • Three key components are: 1) how much Potential CASH FLOW generated per unit (of product or service), 2) how fast you are GROWING, and 3) what the overall and your potential SHARE of the OPPORTUNITY • (prefer to be in billions of dollars) • •
DSP Dev Corp Example
My first company DSP Dev Corp (a scientific digital signal visualization software company), was a leader in the market, after 3 years had $5M in sales, with a 20% EBITDA However, due to a small market opportunity and slowing growth (after hitting $5M), the valuation was roughly $6M If the company was going after a multibillion market, the company would be worth $100Ms at that point
What do Investors Expect
• Angel investors expect you to understand how the market works and that your financial model is realistic • They will also want to understand what the cash flow impact would be when things do NOT go as planned. • VC’s want to understand that the market is very large (multibillion dollar market potential) • …And that your model credibly shows how you can attain your top down share BOTTOM UP and achieve your pro forma financials
Pulse of a Successful Business
• Your metrics for success will change based on business model (more later) AND the stage of your business you are in (e.g. product development; beta test; initial sales; breakeven; expanding sales) • But it is always about impact on cash flow first and foremost; then how your revenues will scale and maintain margin (e.g. product / service margins over time, time to first sale, sales pipeline; A/R and A/P terms; and EBITDA over time (both % and net) • Finally things that impact valuation (e.g. number of competitors, share of wins, overall revenue and margin growth, changes to size of market opportunity)
Consumer Business Types and Monetization Drivers
TechCrunch Teardown: 13 Consumer Internet Business Models (Part I) « The World According To Carp http://fndri.com/jEvuYa - Steven Carpenter
Estimated number to reach $10MM/Year
• What model will you use? How will you model it? • Commerce Example
• Its all about the Cash Flow • Model it and Live It – so you will know what the cash flow impact will be if things (or you think it might) change – they always do! • Live It and Monitor It – internalize the business model and think about how to sustain the business and how to maximize its value
Charles Kwon email@example.com