Your product will never be viable unless you fully understand your financial model

Here is an obvious statement:

'You need to understand the financial model of your business deeply in order to be successful'.

Sounds obvious, right? Wrong.

In my experience, lots of new business owners simply don't invest the time or complete the research required to fundamentally understand their own financial model. Without doing this, they are handicapping their own efforts to succeed.

Generally there are a few hurdles in getting this understanding: Firstly people need to know their numbers, revenue most people know, everything else, in my experience is a mixed bag.
In order to build a useful model you need to know your fixed and variable costs and the relationship between price and cost, sometimes they are tied (commissions, licencing etc).

For me, opening Excel and building a model from scratch takes an hour or so and I can update it as I remember the little pieces I forgot. Excel is essentially one million start-ups in one grid, the ultimate power tool, it has functionality like 'What If Analysis' [ https://www.excel-easy.com/data-analysis/what-if-analysis.html] which enables you to create scenarios and work forwards, or backwards towards a profit level or a cost level. If you're not familiar with this its worth investing two hours of YouTube tutorials, it will powerup your financial understanding 10x.

Once you have this model, you will feel like you have a super-power.

You do have to undertake a significant amount of research in your own business upfront to make these models work, you are going to get the some basic information and it needs to be accurate, the below list is not exhaustive: (I've ranked them easy, medium, hard in terms of how easy it is to collect)

1. Your prices - easy
2. Sales taxes i.e. taxes that directly affect your revenue e.g. VAT - easy
3. Employee costs - easy
4. IT infrastructure costs - medium
5. Cost of product - Is there a direct cost to you in selling one item, i.e. the cost of manufacturer and delivery, a royalty, licence fee - hard
6. Marketing/Advertising costs - seems easy, can be hard.
7. Everything else - (depends on your niche)

For a business like mine, TotalCarCheck.co.uk, it's effectively the cost of staff, cost of IT infrastructure, and the product is built on a 'cost plus pricing model' so the sums are incredibly easy, its effectively volume x profit margin, and the profit margin only changes if there are changes to employees, infrastructure or cost/selling price of the product, this probably represent a large number of start-up's selling at margin.

I find it surprising that many people, with a model like ours, don't actually know their profit margin per product, its literally pure maths and once you have it in a model, you can iterate and experiment with fantasy figures and work backwards to answer questions like:

a) If we reduce our costs by 20% what's the effect on profit margin?
b) If we increase the price by 10% and assume a reduction in sales of 8% do we make more money?

Its fascinating seeing the number move.

Without this, or similar financial model that you can update as often as you like you won't know if you are working hard for less, or missing easy opportunities to increase profit.

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