Napkin Financial Models

Ryan Hatch:

When launching a new venture, it's important to understand—hey, is this thing gonna make money? Is this gonna get me to where I want to be from a financial perspective? And the thing to ask yourself is, Hey, how, how big do I want this company to be? Do I want it to be a lifestyle business, just kind of you and services and pay it makes you a really good living or do you want this to be a scalable company?

Is this going to be a $10 million company? 20? Do you want this to be like a, you know, a hundred plus million dollar company and that matters. Even before you get to that point, you kind of need to ask yourself, is this gonna, is this gonna make me money? Is this going to be a profitable venture? Could it be a profitable venture?

And so we're going to explore today is looking at a financial model and looking at how do I look at the business from a financial perspective rather quickly, and just check my assumptions. Is there something here? Let's jump into it. There's lots of ways to do financial modeling for a startup. One of the things, especially in products in SaSS or subscription-based companies, the primary metrics are two things, customer acquisition cost, and lifetime value. And we put those two together. It's referred to as unit economics. Hey, am I able to make money on each customer? Is each customer profitable? Not looking at it from a cashflow perspective or, or P and L perspective quite yet. We're just looking at, Hey, could this make money on an individual customer basis?

That's called unit economics. Let's take a look. So unit economics is what we're trying to drive towards right here. And we're going to do is we're going to back out of that and move all the way up to the acquisition side of the business. So here we have a bunch of different funnel stages. Step 1, 2, 3, 4, hopefully getting customers to a magic moment where they're really feeling that, Hey, this product helps them and they're going to be paying you.

So this is just one model. There's lots of different ways to do this, but here's an example. If you're doing paid acquisition, which is typical for more startups, especially early, right? You're not going to be investing in SEO and long game. You're going to be doing quick hits to see what messaging works and how fast you can acquire.

So with paid ads, you're going to have some kind of acquisition costs. It's going to start high, right. And high is relative, depending on who you're targeting what keywords you're using whole bunch of different. So you put the acquisition cost in there for a... For just a, just a click, right?

Just on the paid side, but that's not, it, that's not, it's not over. There's a whole bunch of different activation steps you do as you work customers through whether it's you know, downloading an app or, or pro you know, uploading their information and getting their account set up actually starting a free trial, whatever it is, whatever your onboarding experiences you'd put these as steps.

Get them to a magic moment and each time they're going through a step, you're actually losing people. Right? Okay. At this step 80% of the people that are, that are going from, from that step two actually make it to step three, maybe 90% of the people at step three, make it to the, to the next step. You're going to have fall off at each step.

They just want to kind of account for some of that. But again, these are just assumptions, but you have to start with something, right? What do I think the customer journey is? What are the major inflection points? What do I think if we're able to get it right? What are the, you know, conversion rates across that?

What you're doing is you're building a funnel. You want to get down to what that does. Is it kind of calculates for us then what the actual acquisition cost is. Right. If you're getting a click for 77 cents. But you're losing people along the way. Then it's going to take more than one person to get to a paying customer to get through the end of that funnel.

So when you put all those together with these, in this example, the actual acquisition cost for a paying customer or someone starting a free trial in this case is like almost six bucks. So you can't just look at your paid ads. You have to look at the full funnel. The next thing to consider is. Now it's a really high bar to get your customers to that magic moment of, we talked about up here, it's a really high bar.

If you're able to do that, you can also consider, Hey, is this something that people would share and share and talk about just something they would share with a friend? That would really help your acquisition cost as well. But there's a big assumption here. I'd be pretty conservative upfront about what you think would actually happen.

The goal would be for someone to share the average user shares with one other person. It's probably more like point two five people, one and every four persons maybe going to share. And then the people that actually I see that are they going to download or are they going to right. Start engaging in your funnel?

You can put those two together. And, you know, w what it'll do is it'll reduce your acquisition costs, right? So from 5.94, almost six bucks closer, you know, getting closer to five bucks. So that referral actually decreases your acquisition cost. Again, these are just assumptions, right? And I'd be really conservative upfront, especially with referral because the viral component is actually very hard to achieve.

The next thing to look at is retention, right? How long are people staying? In SaSS products we often measure that in number of months, so maybe they stay for six months. And then again, this is a bell curve, right? It's a bell curve. And what you're going for is, is the average, of course, you're going to have people stay longer.

You're going to have a lot of people that stay shorter. So put in what you think the average, this is, again, an assumption is going to be for the retention. Then next is revenue. So for revenue perspective, you know, if it's a subscription product, How much are they paying? Is that monthly? How much they paying per year?

And when you put those two together, you kind of get your lifetime for that customer. So if it's forty-nine bucks a month, six months, it's two ninety-nine is lifetime value. If you have any other potential revenue streams, you can put that in here too. Get the total revenue per customer. When you put it all together, it brings us right down to where we started, which is unit economics.

So again, we want to look at, Hey, what's the customer lifetime for this customer? What's the acquisition cost for this customer? Put those two together and we get a ratio. We can talk more about that another time. And that brings us down to customer lifetime value is how much might we be able to make on a per customer basis?

Now this sets us up. Well, to kind of understand, could we maybe if these assumptions are true, could we make money on a per customer basis? Customer lifetime value. If we are, then we can move forward into other things like market sizing, you know how what's the, what's the market cap based on how many potential customers out there, our reach,  how many we can actually acquire through these channels.

That gives us kind of a market cap. And the other thing to look at is a P and L or income statement, which points us to like a breakeven point based on how much we have to spend to get there, what kind of investment will be required. There's lots of different ways to do this. This is an example. What you want to do is kind of model out the business rather quickly and not spend too much time on it, but just kind of get some gut check assumptions.

Hey, if we're able to accomplish this, if this journey were to exist, where were able to get people through here at this cost. And if they were willing to pay and subscribe, and there's lots of assumptions in here all the way, but if we were able to. Would we, or could we be profitable on an individual customer basis at the unit economics level?

And then you can look at scaling it up from a breakeven and scaling up from a market sizing, looking at costing, how long would it take and how much it take to get there, but also sets you up for assumption testing out in the market, right? Can you actually acquire customers for that amount? Will customers actually move through the funnel?

Like you said, And as, as customers start to move through, then you can update your model to reflect reality and see how that's impacting your bottom line.

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