Why Every Founder Should Understand Their Unit Economics
In my experience working with countless founders, unit economics is probably the most useful and important measure in building a successful start-up. Here's why:
A Language Everyone Understands
Discussing financials on a unit basis is straightforward. For every sale, consider how much revenue is generated (selling price) and, critically, how much is spent on the team, tools, marketing, etc. This clarity helps everyone grasp the financial picture and aligns the team towards common financial goals.
Profitability Insight
Unit economics helps you understand the profitability of each product or service you sell. By breaking down costs and revenues on a per-unit basis, you can see which offerings are truly profitable. This granular insight allows you to focus on products that contribute the most to your bottom line and reassess or discontinue those that do not.
Example:
Imagine a start-up selling custom t-shirts. If the cost to produce one t-shirt (materials, labour, shipping) is £10, and the selling price is £20, the gross profit per unit is £10. If overheads (marketing, rent, etc.) are £5 per unit, the net profit is £5 per unit. Knowing these details helps in setting realistic sales targets and growth strategies.
Scalability Assessment
It’s vital to ensure that your business model can scale efficiently. By analysing unit economics, you can predict how costs and revenues will evolve as you grow. This involves understanding fixed vs. variable costs and how they impact profitability at different scales of operation.
Scenario:
Consider a software-as-a-service (SaaS) start-up. Initially, development costs are high (fixed costs), but as more customers subscribe, the additional cost per customer (variable cost) is low. Understanding this dynamic helps in planning for future growth and investment needs.
Cost Management
Detailed knowledge of your unit costs helps you find opportunities to reduce expenses without compromising quality. This is critical for charting a path to profitability. Regularly reviewing and optimising production processes, supply chains, and operational efficiencies can yield significant savings.
Practical Tips:
Negotiate with suppliers: Secure better terms as you scale.
Streamline operations: Implement lean manufacturing or service delivery techniques.
Automate repetitive tasks: Invest in technology to reduce labour costs.
Pricing Strategy
Understanding your unit economics enables informed pricing decisions. If cost-cutting opportunities are exhausted, determine how much to raise prices to break even. Additionally, assess the impact of discounts on your margin per sale.
Example:
If your analysis shows that a 10% discount decreases your margin by 20%, you may decide to offer smaller discounts or only during promotional periods to maintain profitability.
Investor Confidence
Investors are keen on founders and start-ups with a clear grasp of their financial metrics. Demonstrating a thorough understanding of your unit economics can significantly boost investor confidence and help secure funding. Transparent and accurate financial data instils trust and showcases your business acumen.
Key Metrics to Present:
Customer Acquisition Cost (CAC)
Lifetime Value (LTV)
Churn Rate
Gross and Net Margins
Data-Driven Decisions
With a deep understanding of your unit economics, you and your team can engage in healthy debates and make informed, data-driven decisions. This approach minimizes guesswork and helps in crafting strategies that are rooted in financial reality.
Decision Areas:
Marketing Spend: Allocate budget to channels with the highest return on investment.
Product Development: Invest in features or products that promise the best margins.
Expansion Plans: Choose markets or segments with favourable unit economics.
Conclusion
Mastering your unit economics is about ensuring your start-up is not just surviving but thriving. It's about making smart, strategic decisions that pave the way for long-term success.
Give it a go: At its simplest, take your revenue and costs and divide them by the number of units sold—hey presto, you can now see the revenue and cost per unit. Turn it into a chart or graphic to bring it to life for your team.
Need some help? Get in touch! Don't let your numbers be a mystery, embrace them as your superpower!
Why Founders Need to Know Their Numbers
As a start-up founder, knowing your numbers isn’t just about crunching data; it’s about understanding how your business is performing and how effectively you're investing limited resources.
Financial Health
Understanding your numbers gives you a clear picture of your business’s financial health. It reveals where you are generating revenue, where you’re spending it, and how long your cash will last. Key financial metrics put this information at your fingertips.
Informed Decision-Making
When you know your numbers, you can pair your entrepreneurial instinct with data to make more informed decisions. From pricing to operational changes, data-driven insights lead to smarter choices.
Spotting Trends and Patterns
Monitoring key metrics helps you identify trends and patterns in your business. This foresight enables you to capitalise on opportunities and mitigate risks before they escalate.
Effective Resource Allocation
Knowing your financial position allows you to allocate resources more effectively. Whether it’s optimising costs, investing in growth areas, or managing cash flow, informed resource allocation is key to sustainable growth.
Building Investor Confidence
Investors are more likely to trust founders who have a firm grasp of their numbers. Clear and transparent financial reporting instills confidence and enhances your credibility in the eyes of potential investors.
Navigating Challenges
Inevitably, challenges arise in every start-up journey. Knowing your numbers equips you to navigate through tough times with resilience and agility. It enables you to proactively address issues and pivot strategies when needed.
Setting and Achieving Goals
Your numbers serve as benchmarks for setting realistic goals and tracking progress. Whether it’s achieving break-even, reaching sales targets, or scaling operations, clear metrics guide your path forward.
Conclusion
It’s not about memorising figures; it’s about wielding numbers to understand your organisation’s health and progress. As a founder, knowing your numbers empowers you to steer your start-up towards success.
Embrace your numbers. Understand them. Use them to drive your business forward.
Need help understanding and leveraging your business numbers? Contact me for personalised guidance and support on your journey to success.
The Real Founder Success Story: Achieving Break-Even
In the world of start-ups, securing funding is often hailed as the pinnacle of success. However, there's another equally rewarding milestone: achieving break-even. This moment marks a game-changing position where funding becomes a tool for acceleration rather than a necessity for survival.
Having helped several founders reach this point, I can attest to the profound impact it has on a business. Here’s a breakdown of the key steps we followed:
1. Understand Unit Economics
It's crucial to grasp how revenue is generated and how expenses are incurred. This involves a detailed analysis of each unit of product or service sold, identifying the cost to produce it, and understanding the profit margin.
2. Assess Cash Position and Burn Rate
A clear picture of the current cash position and the rate at which the company is spending money (burn rate) sets the foundation. This helps in defining the timeframe for achieving break-even and ensures the business can sustain itself until this point is reached.
3. Evaluate the Cost Base
Identifying cost reduction opportunities without compromising the quality of the product or service is vital. This could involve renegotiating with suppliers, optimising operational processes, or finding more cost-effective solutions.
4. Analyse the Market
Optimising revenue through strategic pricing and market analysis is another key component. Understanding the competitive landscape and customer willingness to pay can help in adjusting prices to maximise revenue.
5. Plot the Path to Break-Even
Finally, developing a detailed plan with clear actions, key decisions, metrics, and milestones ensures everyone is aligned and working towards the same goal. This plan should be revisited and adjusted as needed to reflect changing circumstances.
Conclusion
Helping founders achieve break-even is not just about financial stability; it’s about transforming the business and unlocking new possibilities for sustainable growth. It’s a testament to strategic planning, disciplined execution, and a deep understanding of the business’s fundamentals.
By focusing on these key areas, founders can not only survive but thrive, making funding an optional accelerator rather than a lifeline.
Ready to transform your business and achieve break-even? Contact me today for personalised guidance and support on your journey to financial stability and sustainable growth.
Understanding costs: The foundation of effective financial planning
Understanding your costs is critical to putting yourself in a position to plan and optimise the most impactful way to invest your limited resources.
For any organisation, the number one financial question that should be asked is: "What is the most impactful way that our limited resources can be invested?" While this is a straightforward enough principle, in reality, an organisation's costs are complex, and almost always you aren't starting with a blank piece of paper but rather have activities already committed and ways of working established that define your "cost base."
Understanding your costs is critical to putting yourself in a position to plan and optimise the most impactful way to invest your limited resources.
Broadly speaking, there are two categories of costs:
Costs of Sale (aka Costs of Goods Sold or Operating Costs) - the costs you incur in the delivery of your principal organisational activity, e.g., making and selling a product/service.
Overheads - the administrative costs and critical infrastructure that support the organisation's smooth running. The most typical overheads are things like office rent, finance, legal, and HR costs.
Why is this distinction so important?
Management of your costs of sale goes hand-in-hand with your pricing and sales strategy to ensure that your product/service makes a surplus, aka a gross profit.
Overheads can be optimised, but ultimately need to be funded out of your gross profit, and a key part of strategic financial planning is determining how this will be done through one or a mix of volume (how many things you sell), increasing profitability (price increase/costs of sale reduction), and expansion (introducing new products/services, opening a new store, trading overseas).
Regardless of category, there are broadly three types of cost:
Fixed - Do not vary with a change in the scale of your business (e.g., increase in the number of products sold or number of people employed).
Stepped - Increases when a threshold is hit, e.g., office costs will be fixed until you exceed the capacity of your office and need to open another one or move to a bigger office when it will once again be fixed until that capacity is hit and so on.
Variable - These vary either exactly or approximately in line with another variable, e.g., the cost of components for a product will directly vary with the volume of products.
Analysing and understanding both your existing costs and any new costs through this lens is essential for effective financial modelling as it ensures that you create the appropriate relationships between business activities/decisions and costs.
Fixed costs may be significant when they are first incurred but may be quickly paid for as revenue increases.
Stepped costs may mean your cost base significantly alters at key points in your organisation's growth, e.g., an additional production line or machine being required once volume exceeds a certain amount, or an additional person needing to be hired to ensure you can service your clients to the standard you want.
Variable costs will directly influence the price of your product/service and therefore your positioning in the market and the types of customer you target.
Understanding the two categories and three types of cost is the foundation from which you can map your cost base to identify how it can be optimised or a lens through which you can evaluate both short-term decisions and long-term strategic plans. These categories are also the fundamentals with which to build an effective financial model.
Need help with your financial modelling? I can help
Financial modelling for fundraising
One of the main reasons people need a financial model is because their organisation as at a stage where it requires external investment. A key part of securing investment is being able to demonstrate to prospective investors how their money will be used and when they can expect a return
One of the main reasons people need a financial model is because their organisation as at a stage where it requires external investment. A key part of securing investment is being able to demonstrate to prospective investors how their money will be used and when they can expect a return from their investment (with the exception of philanthropic and some impact investment).
What do investors expect?
For an investors, a financial model is
demonstration of financial diligence (is their investment in safe hands)
a translation of strategic plans (usually set out in your pitch deck) translate to income and expenditure
a tool to evaluate sensitivity to changes (ie risk)
RIghtly or wrongly, a financial model has also become a standard way of articulating your business through numbers. This is because the common structure allows prospective investors to quickly zero in on key metrics they care about and compare them against other investments they hold or that they are considering.
3 statement financial model
The most common form of financial model is called a 3 statement model so called because it is built around 3 interdependent financial statements:
Income statement or profit & loss (‘P&L’)
Balance sheet
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These are the same 3 statements as you will find in company accounts which is why investors find them so useful - it allows them to compare what you are putting forward not only against other investments, but also against other similar businesses that are already trading.
How do I create a financial model to raise funds?
It’s all too easy to jump to the conclusion that for investment all you need is a 3 statement model. In reality, a successful fundraise is underpinned by a clear plan as to how you are going to achieve the vision that you set out and financials are just one (critcal) part of this. In my experience, the most effective and useful financial models for fundraising go through 3 stages:
Evaluate & understand existing business - before making any future plans it is critical that you evaluate what has actually been happening as this is ‘fact’ rather than an estimate as to what might happen. This is important because any future plans will be an avoluation from where you currently are and your fundraise will need to be able to articulate how you get from A to B. It also allows you to see what is working versus what needs attention for example: how much additional volume is needed for income to cover cost (growth to break even), or unit economic analysis might help you explore how income and costs need to change to achieve profitability.
High level working model - just as a pitch deck starts as sketches on a notepad or whiteboard, a financial model is best not over-engineered so that structure doesn’t constrain creative thinking and exploration of different approaches. This stage will likely be a mess of various Google Sheets or Excels but embrace the mess! This is an opportunity to explore different scenarios around key strategic paths that are key parts of the fundraising pitch e.g. how changes in unit economics and volumes impacts income & expenditure, or maybe a top level analysis of if volume grows by x% each year, what topline revenue does that achieve by Year X? These rough workings help support the wider development of the pitch deck, identify key metrics to focus on, verify how much funding is needed, and ultimately give you clarity on how your financial model will be structured (making it quicker to build and less prone to errors through iteration).
Investor ready model (3 statement model) - with clarity over the key variables and a clear understanding of your actual financial data, the investor ready model becomes more about transferring the outputs of stages 1 & 2 in to a 3 statement model format and finessing such that it clearly aligns to your investment story - critically, the key inputs & outputs that will quickly allow prospective investors to understand how your strategic plans translate to numbers.
All of the above can be undertaken internally, in particular, stages 1 & 2 require no financial or accounting expertise. Seeking assistance from someone outside your organisation however is extremely beneficial 2 reasons:
Independence - not being involved day-to-day means someone external will draw insights and bring ideas that you would be blind to. Even if not directly, this alternative thinking may lead to the breakthrough moments in developing a compelling investment pitch. Experience from other organisations will bring invaluable learnings as to what has or hasn’t worked elsewhere.
Expertise - while you may be numbers savvy or even have a dedicated finance person or team, building a long term strategic model for investment i very different to day to day financial management. It is also a significant investment of time that existing resource does not have the capacity to take on meaning either the day-to-day falls by the wayside or the investment model is of low quality or has errors due to attentionbeing spread too thinly.
However you approach financial modelling for raising funds, remember that it is an integral part of process alongside the pitch deck and should be treated as such - an evolving tool that articulates your vision through numbers so that you are able to create a compelling investment proposition.
What is a financial model?
At its heart, a financial model is the translation of actual and projected operations in to numbers so that you can understand and project the financial implications of whatever you are trying to achieve.
While they are often prepared by finance professionals, a financial model is simply a tool you use to help you achieve a goal so ‘what it is’ depends on what goal you are trying to achieve.
At its heart, a financial model is the translation of actual and projected operations in to numbers so that you can understand and project the financial implications of whatever you are trying to achieve. Financial models are invaluable tools in a number of scenarios including:
Raising funds - helping you translate your future plans in to financials so you can understand how much money you need to raise and be able to articulate to potential funders how their money will be invested and how they can achieve a return on their investment
Making business decision - a financial model allows you to evaluate the implications of a decision from confirming how much something will cost to evaluating the impact of price changes or investing in a new product line
Developing budgets & forecasts - the periodic process through which operational plans are optimised and translated to financials thereby setting out how much is expected to be spent on what and why, and how this relates to the income that the business expects to generate - this is a critical element of financial governance and empowering people in the organisation to make decisions
Knowing how long your cash will last - no cash = no business so particularly in early stage businesses, understanding cash runway ensures that you can be on the front foot both in terms of most impactful investment of your limited funds and being in control of when and how you raise funds
Understanding your business - analytical reviews such as product/service profitability or a cost base deep dive enable you to make informed changes to achieve improvements in your commercials
Okay, so there are a number of different reasons that one might use a financial but what do different types of financial model look like? There are some key elements of a financial model that change depending on what you are trying to achieve:
Single use vs ongoing - some financial models will be used to make a decision at a point in time and then their job is done. Others, will become the financial reference point for a period of time or be updated with actuals or new assumptions. Ongoing models tend to be more complex and take longer to build because
Who it is for - different audiences will prefer, or may even require certain elements from a financial model. Professional investors such as VCs for example typically require an Excel based 3 statement model, while an internal foreacast may use an FP&A tool that integrates with your accounting system and an internal business case may be a simple Google Sheet
Whether it includes actual data - budgets and investment models typically require 1 to 5 years of actual data both to help project the future and assess metrics such as year on year growth. The structure of the model will either need to align with the existing data or a schedule will be required to translate the historic data in to the format for the model. This can become even more complex if multiple different historic datasets are brought in to the model (e.g. multiple entities, data from multiple systems, financial and non financial data).
Variables & scenarios - the higher the number of variables that you want to be able to change the more complex a model becomes, especially if the variables are related to each other. Some financial models benefit from going a step further and modelling ‘scenarios’ where groups of variables change (e.g. best case, expected and worst case).
Regardless of the type of financial model and its purpose, there are 3 critical elements:
Inputs - key variables that you want to be able to adjust. These may be variables that you control (e.g. price, volume, date that something is effective from), or external factors that significantly impact what you are modelling (e.g. inflation, supplier price increases, minimum wages increases, seasonality)
Workings - the detailed mechanics of the financial model process the inputs and turn them in to the relevant financial schedules (e.g. P&L, balance sheet, cashflow forecast, payroll workings, product level income and costs)
Outputs - a high level summary of what the financial model is saying that is easy to understand, often includes visualisations as well as tables and clearly answers the question that is being asked of the model
Whatever you are trying to achieve with your financial model, having a clear articulation of the business need before you start will help you identify what sort of financial model you need, the data you will require and an idea of how simple of complex it will need to be.