How Important Is Your Financial Model

And even though we've grown and scaled our business up, we're actually making less money. So we want to be very clear on how this model works and how it impacts us as we grow our company. Hey, everybody. Bob Govreau here. Super excited to welcome you to the Wealthy Entrepreneur podcast. Ultimately, our goal here is to empower business owners just like you to grow, scale, and ultimately change the world with the great things that you do. Now, I'm really excited today to talk about something that is one of my favorite topics, and that is what a business financial model is. And before you turn it off and go, Bob, that sounds really boring today, I will make it exciting, trust me, because it leads to you making more money. And when you make more money, you can have a greater impact and in your life, in your business. And that ultimately, you know, whether it's making money or it's making impact, one of those two are really a primary focus for us. But it all starts with focusing on driving profits. More profits mean more impact. So let's talk about the financial model. Now, before I actually get into the details, I want to just share with you that so many of our clients, at least at the beginning of their journey, have struggled with understanding what their financial model actually means. And why is this impacting to you? Well, if you don't understand how the financial model works, you likely aren't pricing properly. You're likely inefficient in delivering either your service or your product. Your gross profit margin is probably really low, and you're probably making less money than you should be in your business. And in order to change that, you have to have a good understanding of how all of these components come together. And what I'm going to do is I'm going to share with you how this works, and then I'm going to share with you a case study of a client of mine that I've been working with over the last couple of years and how understanding the financial model has transformed their business so that they're now making upwards of a million dollars a year. So let me jump right into this financial model. It has three main components to it. It also drives a lot of financial optics. There's lots of measurables that come from this, but the financial model has three main criteria. Okay? The very first one is something that we can all relate to, and that is revenue. So revenue is price times quantity. So whether it's a service, it's the price of a service times the amount of times we're delivering that service equals revenue, or if it's a product, it's price times the quantity of that product equals revenue. Both of those are essentially cash that is being generated that should be collected at some point in our business. Now, I'm going to do a quick side note here that revenue doesn't always equal cash flow. And this is where sometimes businesses get into a little bit of trouble. And that's thinking that revenue is just driving profits. And profits are going to be great. We're going to have lots of money in our bank account. But if revenue is not actually collecting cash. So if you're delivering a product or service and collecting the money down the road, you're having accounts receivable set up, your revenue and your cash flow will not equal each other. In fact, your revenue might be driving a great profit, but you might be running out of cash in your business. So you need to be aware that there's a few different components to this. Right? So revenue doesn't equal cash flow, although in many instances it can. In fact, we want to actually have more cash flow than revenue. That'll be for a different day. But component number one of the financial model is revenue. So price times quantity, the second component of the financial model. And this is where it starts to get a little bit more what you're talking about there, Bob. But stay with me. We're going to walk through it from beginning to end. Okay? So the second component of this financial model is the costs associated with delivering revenue. So normally you've heard cost of goods sold, direct costs, variable costs, costs of delivery, anything, any costs specifically incurred that relate to driving that revenue. And I'll share with you why it's important in a minute that we understand this and we differentiate it. But in essence, if you think of buying a product, for example, let's use a computer. So we're buying materials, we're buying processors, we're buying screens, we're buying the physical aluminum that goes into building it. We've got a keyboard. All of those components are considered either raw materials or they're considered purchases. Those are costs that are incurred to sell one computer. If we sell two computers, we need double the raw materials. So in this particular example, as we sell more computers, we're going to equally have to buy more and more supplies. If we sell three computers, we're going to have to buy the products, materials related to Building 3. We also have labor, so the labor to put all these things together. So if we have one computer, we have labor at one quantity. If we have three computers, we've got More labor because they've got to pull three together. You can see how this is starting to work. There's freight likely included in getting access to all of these products or in delivering this final computer to our clients. That's a cost of delivery. There might be fuel costs, there could be lead generation costs. So for every computer that we sell, we likely know what our cost of acquisition is for a new customer. So any of those direct marketing costs are considered costs of delivery. If you actually have to drive in a vehicle to deliver this computer to your end user, then you've got vehicle expenses that are in there that are being incurred to drive back and forth for deliveries. As you can see, and this is just an example with a computer, there's a lot that goes into actually building this. But what we really want to get down to is how much profit we're making on every unit of sale. So again, this is a product based business, but we could also have a service based business in the same example. Service based business, you know, you have a $10,000 sale, you're likely going to have direct marketing costs, you're likely going to have labor costs, you might have vehicle expenses to go to and from a location, if that's necessary. You might have subcontractors that come into play where you bring in experts or legal representation or other professionals in that might be cost of delivering that service. All of these are costs that we need to understand go into selling a product or service. Now this is important again because we want to identify what our profit is per unit of sale. So if it's per service line, we want to know we make 20% on every time we deliver the service or 30%. And if it's on a product side, we want to know the per unit sort of profit amount. So if it's $100, if it's $500, and we also want to know our profit margin on that 30%, is it 40%? This becomes so important as we go from a company that's, you know, $250,000 in revenue, right? We're a service based business for $250,000 in revenue. It's grown up to that. It then we get to a scaling component where we want to go from 250 up to a million. We need to be very clear on this because if we don't know how much our profit is on every single unit that we're delivering or every single service that we're delivering, then we might be going in blind to just saying we're going to Build more revenue and the costs are going to come in and we might lose our profit. And then all of a sudden our business isn't making money. Okay, so this is why understanding that cost of delivery is so, so very important. Let's talk about the third component. The third component sort of caps this off. And that is our fixed cost component, sometimes referred to as overhead. So in this case, we've got items like our insurance for our business. We've got management salaries, uh, maybe our administrative salaries. We've got maybe marketing agency fees not directly tied to a specific lead gen, but that we're paying, incurring a fixed amount every month for them to do marketing for us. Rent, bookkeeping costs, all of these are typically a monthly fixed amount. And what does fixed mean? Well, it means If I sell 10 units or 15 units, the cost of those aren't going up. If I sell 15 units, my insurance isn't going up, my rent isn't, isn't going up. I don't need a bigger facility because I sold a few more units. Okay, now we might get to a point where we need a bigger facility because we're just doing so much more. But it's not directly tied to incurring extra costs when we sell more revenue. It might just incrementally happen. So again, now we've got the picture. We've got revenue minus cost of delivery equals gross profit, gives us our gross profit percentage, which is very important. Less our fixed expenses gives us our bottom line income. All right, so as you can imagine, if our business, we have a 30% profit margin and we double our sales, our profit margin should stay at 30%. We need to monitor this as we grow and scale because I've seen in many situations, and I'm going to share an example in a minute. Many situations where we go from 250,000 in revenue all the way up to a million, but our gross profit goes from 30% down to 10%. And even though we've grown and scaled our business up, we're actually making less money. So we want to be very clear on how this model works and how it impacts us as we grow our company. So I just want to share with you guys one example. I have a construction client. The owner's name is Steve. He's a $4 million a year revenue. So he's grown his company a lot. And he, he has got a 2% net income. And ultimately when we did this review, he had a about a 10% overhead cost. So on 4 million, that's $400,000. And his profit was only about 15%. So that would have him at essentially a net income of 5%. 5% net income on a $4 million business is very scary. And here's why. If all of a sudden our costs of delivery go up 5%, then we are essentially not making any money anymore. So that would drive our gross profit down. Our net income would be zero. We need to understand how this works. Now, my client, Steve, he didn't really understand that his business was in high risk. He didn't really understand how his financial model worked. He was just focused on bringing in more and more revenue and hiring more guys in his construction business to try and keep up with all the work. And although it was still in a positive profit amount, his cash flow was negative and his business was in jeopardy. So when we did an identification of his business model and his business financial model understood that his gross profit percentage was really low, was only 15% and his net was five, it was actually two. But we essentially, within the first month, we got up to five. What we did was we looked at his pricing strategy, and as you can imagine, the variables that come in here, price times, quantity, cost of delivery, overhead costs, those are the four, essentially items that we can manage. So the easiest one to look at was, okay, well, if we ended up, Steve, if we ended up increasing your price here, what does that do to your profit margin? So we actually took him with a small, you know, 3 or 4% price increase. We took him up to a 20% gross profit percentage, which allowed him to get up to that 10% net income amount again on. On a $4 million company, that was now $400,000 of net income in his business, which was good. It's still a little scary, though, because very quickly costs can cut into that and get upwards of 10% if we're not careful, especially labor costs. You got to be really careful monitoring our labor costs. So. So he's now always looking on a monthly basis at his financial model and the outputs. His revenue minus minus his cost of delivery equals gross profit. Gross profit minus overhead equals net income. He's looking at those percentages every single month so that he can identify any patterns of behavior that are putting his business back in jeopardy. In fact, we've got a rollout strategy on price increases over the next 12 months that will get him upwards of a 20% net income amount. And I'm going to share with you why that's a bit of a benchmark in a second. And as we continue to roll out that Pricing, his objective is to manage the cost of delivery, right? Make sure that his cost, his purchases are as low as possible, manage his labor costs to make sure it's as efficient as possible. Ensure that his lead acquisition costs are, are managed low and maintained well. Everybody is being held accountable on this deliverable side. So that as he continues to increase his price up to a more market level or even as a premium price, he's going to take those increases and drive it straight to his bottom line. So by the end of the year, we're going to have him up to a million dollar net income business which should really be a goal for all of us. Now I mentioned 20% as a net income benchmark. When I worked with Tony Robbins back in his business Mastery events, he always talked about the fact that he had multiple companies. 30, 50, 80, I can't remember how many he had. He was fully invested in a lot of businesses, but really the one that he was actively involved in was his speaking engagements. Obviously it required him. So all of these other businesses that he was actively involved in, Tony would say, okay, well because I'm not actively involved and I'm not in the day to day, what I do is I look at my financial performance every single month. Again, understanding how this financial model works. And if the company was greater than 20% net income and he could see a few of the other metrics like the revenue was slightly going up, the costs were being maintained as long as it was at 20% net income as an investor, he felt that was a strong enough performance and he would carry on to reviewing the next company. So 20% is a nice little benchmark to say we should in our business be getting at least a 20% return on all of our efforts because we have more risk as a business owner. You know, this isn't a 3% return market. We can get that in a GIC from the bank, we can give that to them and they'll give us that piddly little return. This is not what we should be generating from our business. We should be generating at least 20% as a net income. And this is, you know, all the way from a $250,000 business up to a multi million nine figure business. We should be looking at as we scale, the goal should be 20. When we're smaller, it should be even bigger than 20. All of this comes from understanding how our financial model works. Okay, so just to summarize this episode for you, this is understanding your financial model. Why is it important? Well, if you don't understand Your financial model, as you grow, you could be losing money. And it's so important that you pay attention to this, especially as you grow and, you know, added a bonus. Make sure you're reviewing the actual results of your business on a monthly basis by looking at your financial model and saying, this is good performance, this is bad performance. Good performance. How do we repeat it? Bad performance. How do we eliminate it so that we can change now and get back on track? Super important. So this is understanding our financial model in our business. I definitely have a document here for you guys. In fact, I'll do one better. Instead of giving a document, I want to offer you each a free financial review. So if you're hearing this and you're going, Bob, you know, the financial model seems complicated. You know what, we're going to put in a link here for you to book a meeting with our team. They're going to help you understand your financial model, how your business is performing, to identify some of these key benchmarks. What's your gross profit margin, what's your overhead costs? Obviously, what's your revenue, and what is your net income? We will walk you through this, help you understand your financial model so that you can position yourself and your business to understand this better and to have outcomes on a monthly basis where you're reviewing this to ensure you're on track for success. So hopefully that's super valuable. The link's going to be below here. Make sure you jump on a free review with our team. Want to thank you guys for joining this particular episode. Financial model is super important in your business. I'm super passionate about it because this may be one of the most valuable tools you can have in your business to make sure that you know you're on the right track to achieving financial success. So if you like this episode, make sure you give us a comment, give us a like, give us a follow on whatever your favorite podcast stream is. Can't wait to have you at the next episode and wishing you guys all the financial success in the future.