You can’t run a business you don’t understand 📊 Lauren Pearl

He turned to me and he goes, Lauren, this business has to shut down. Brian knew more about my company in 2 minutes than I ever did. If you look at it and you just say, oh, that's $100K, great, I can afford $100K, good, you're gonna be very disappointed when you discover actually for your unique business, and especially 'cause it's the first time hire, so it's the first time you're doing all of this, in total it ended up being more like $200K. I definitely knew the business needed to close a month or 2 before I actually closed it. The earliest stage model before the business exists yet, isn't a forecast, it's a feasibility study.

This week's Millennial Master is Lauren Pearl, a startup finance advisor who also teaches financial modeling at NYU Stern. She grew up inside her family's retail business and learned finance the hard way after the numbers exposed problems she hadn't spotted. In this episode, we talk about how to test if the business actually works, the key numbers founders need to know, and where growth forecasts go wrong. Let's get down to business, Lauren, because you talk quite openly about your family's shoe business being where finance became real for you. And before we get into what happened, I'm wondering what were you actually responsible for in the business at the time?

Sure, actually, so throughout my life, I've worked alongside this business sort of since I was born. My father purchased the business, it was going under, it was one of the oldest shoe companies in the United States. He bought it when I was a little baby for $4,000, for very much money, and grew it from what was essentially just a brand name into a 7-location retail chain throughout the Northeast. My jobs over the years included salesperson, shipping and receiving, inventory. Um, I did purchasing. I worked in the accounting department. I helped open stores. I helped close stores. I was really just kind of all over the place. Kind of preparing to eventually one day potentially take it over. And turns out, as the last of 5 siblings, I got the short straw and ended up being the one slotted to do so. So, eventually training to be the CEO.

So, you had a baptism through all the areas of the business, pretty much.

I did. I did. I still remember, I have these great memories of sitting with all of my siblings. I'm the youngest by at least 10 years, so 10 to 20 years older. And so, we would sit in the back room gluing in inner soles. The company had a little manufacturing arm as well, but they came without inner soles, which is the lining at like the footbed where your foot sits. And so I remember sitting in a little assembly line with all of my siblings, and they were teaching me how to write my name in shoe glue, and then we'd cover it over in glue and stick it in the shoe. So really, truly, yeah, grew up very much in the business doing all the weird jobs.

And at that time, how much did you understand about how healthy or unhealthy the business really was?

Great question. I think growing up in the family business, you know, the things you grow up with, you just assume everything's normal. So I remember growing up thinking that every person's dad ran a business and, and that's just how everyone made money. And, you know, eventually I realized that wasn't always the case, but in my purview, I heard about the day-to-day issues going on, but I kind of assumed everything was fine. And quite honestly, I kind of had that right in the early days because We had a lot of success in the business. My father was able to grow location after location. At the time, he was picking areas that didn't have a lot of competition, and the shoe business was doing well. And, you know, eventually that would change, but for most of my growing up, things were generally going okay.

And you worked with the CFO on one of the struggling shops, if I'm correct?

Yes.

What did the numbers actually show you at the time, or what did you understand from those numbers?

Yeah, so that was later on in my experience with the business. Growing up in the business, it was sort of almost just the typical kid job where you're low on the ladder and you don't have much to do with the big decision-making. But after college, after being a developer for a couple of years, I rebelled and went into software and then very quickly realized, okay, I actually do really like business and came back. And in In that moment as an adult, I was working on more high-level things, working alongside the CFO, watching the CMO, going to shows and really picking product lines, figuring out how to optimize inventory. So, with the CFO, I recall the beginning of the conversation being seeing the numbers for the store and seeing that they weren't doing very well. When you have 7 stores, you can kind of compare a bit apples to apples. What are the revenue numbers we're hitting? What are the costs going into running each of the stores? Because we have to staff a certain number of people, there's regular regulations and constraints on what can happen from city to city. So all of these things differ. And for this store, the sales just weren't hitting in the way we were seeing in the other stores.

Mm-hmm.

I became part of that decision, I think in part because we needed to not just close down the store, but convince my father at the time that it's worth closing down. And it was one of my first lessons actually in understanding how emotional business can be and how working alongside CEOs, you really need to be sort of the steward of the truth. You can't just tell the person what's necessary. You have to frame it in a way that makes sense to them and that emotionally they can tolerate. So a lot of the reason I think I was pulled into that decision, I wasn't yet a finance expert, but I was an expert in thinking about how do we explain this? How do we frame this in a way where it's a decision that this owner can make? For us, it was just about instead of, this is a failure, let's cut, let's cut this store. It was very much about, let's see what we could do with the money if we close the store, how much more inventory we could buy for the others. Here's the new product lines we want to build that we didn't afford, we couldn't afford before, but we could afford if we shut down this store. And that was the trigger that allowed us to actually take action quickly and close the store before it really dragged us down.

And if my research is correct, we're looking at about half a million dollars in inventory elsewhere released. So that was an easy-to-convince figure, right?

It was, but again, the other challenge of working with CEOs, and again, it was one of my first lessons in this, is the numbers aren't everything. Even if it sounds like a lot of money, it still can sometimes not be the language that a founder speaks, right? Some founders will hear half a million dollars in inventory and get really excited, right? Other founders can't really gauge that against other issues that are really driving them crazy, and so you have to be thoughtful about what works for this particular decision maker to make it real for them.

And we're possibly going to touch on a few types of people and how they operate mentally, because I liked what you said there about you can't give them the facts and the truth straight on. But I wanted to come back to the family business and I'm curious when the wider family business eventually closed, what did you realize you hadn't understood early enough, even when you took those decisions with the shop closure?

Yeah, so this really pulls back to my sort of arc story with the company. So Kind of sequence of events. I grow up alongside the business. I leave, go to college. I decide I wanna rebel, become a budding software engineer, realize, okay, fine, I do wanna do the business, come back. And when I came back and sort of had this adult role in the company, I was realizing, okay, things aren't going great here. Like, we're shutting down this store. We have like unpaid bills. We don't have all the inventory we want. Things seem to be not going smoothly. And I don't understand how to fix it because I came in as a developer. I don't have a business Education. So I went to business school because I wanted to kind of learn the language of business and understand how to fix it. I thought, okay, I'll go to a big fancy business school and I'll learn all the things you need to know, and then I'll come back and then everything will be better. And in fact, what happened was I went to a big fancy business school and I sat down alongside one of my classmates. I remember the room we were in. His name was Brian, and he had worked in finance already for years before business school. And I sat down with our— Profit and loss statement, one of the income statements that, the income statement, one of the financial statements that you review to understand the health of the business. And I figured this would just be a fun exercise in learning how to read financial statements. Dummy, I don't know how to, I'm a software engineer, I don't know how to read a financial statement. So I'm all excited, I go sit next to Brian and he's all excited, he's going to show me something cool and fun. And I just remember his face went white. Oh my gosh. Like his expression totally changed and he turned to me and he goes, Lauren, this business has to shut down. And it was this gutting, scary moment because what he saw in those numbers, what was that this business was beyond repair. These unit economics weren't working. These, uh, the cash wasn't working. The debt wasn't working. We can talk about what those things mean, but it just wasn't going to work. Which is a sad story. We shut down within the year, but there was also kind of a hope side to that story. Because that moment became the inspiration for why I then got interested in finance because I had worked in the business for 27 years up to that point. And Brian knew more about my company in 2 minutes than I ever did.

From glancing at the P&L.

And so I realized that, wow, like this is where the answers are. If I wanna be a skilled business person or if I wanna help someone else run a business, This is the language I have to learn how to speak to understand what's really going on. And so that's really kind of been my inspiration for what I've done ever since.

So fast forwarding then to today and your experience you had with founders, why do you think smart founders hand the numbers to an accountant or finance person and mentally go, right, that's handled?

I think it may be different for everyone, but I think there's so a range of reasons that I see often. One, they don't under— They don't understand the numbers. They're scary. They intimidate them. So they just want to get rid of them. That is definitely one thing that happens. Oh, that's not my job. Pass it elsewhere. The other thing that can happen is, yeah, I kind of like this, but it's annoying. I'm not passionate about it. It's all bean counting. This is the details. This is the, this is the administrative.

And usually the founders are builders, makers.

I make stuff. I build stuff. I don't want to be bothered with all of this administration in the background. But honestly, I will tell you, most times reason number 2 is reason number 1 in disguise. Most times people who are feeling like, oh, this is not my job, it's too tedious, it's too annoying, it's actually because they don't get it. They don't understand. Like, I'm a rather clever cookie and I've worked in finance exclusively for the past 10 years, and it is riveting. Like, it is super interesting. It's really weird. It's really nuanced. There's so much data analysis. There's so much precision. It can really just break your brain. It's a really fascinating topic. And if you're working in any kind of business, it's a really easy thing to kind of toggle up and down between the financial implications of something and the business strategy of something. It's a really interesting exercise. So I actually think really smart people who have that, like, finance is just annoying, It's probably because they don't get it. And annoying is another way of saying, I don't understand, or I'm kind of nervous about it. I'm kind of intimidated by it.

And that was one of the main lessons that I pulled from my episode with Melissa, who introduced us. And the specific line was that you can't manage what you don't understand.

Totally. It's so true because you, when you're running the business, can often see symptoms of financial issues, but you can't really get at the crux without looking at the numbers, right? At the end of the day, like it or not, business is numbers. Even if you don't look at them, they're happening in the background. So if you don't understand how to read those numbers, you're basically choosing to run your business without knowing what actually is going on.

So say you don't know what's going on, your business grows, and you've hired someone really good who still has to stay in the business and make sure that things are running properly. What Should a founder be able to explain about their business without ringing the finance person?

I would say 2 things. First, we want to think about sort of the business fundamentals, which I can discuss. And then the second thing would be on an ongoing basis, understanding key matrix, or excuse me, understanding key metrics. So the foundation of the business, I like to describe this as Stepping back, there is an equation called the profitability equation. It's how you calculate profit, right? And profit is revenue minus costs equals profit, right? Sometimes you can break it up into revenue minus costs, fixed costs minus variable costs and this sort of thing. But at the end of the day, right, this is the end of the day, the most, at the end of the day, the most minimal way to describe it is profit is always Revenue minus cost. In every single business, this is the same. And understanding the fundamentals of the business is knowing how that formula gets calculated for your particular business because it breaks down, right? Revenue isn't just revenue. Revenue is the different sales that you have for different kinds of products. Some of the products are sold on a per, uh, product basis. Some are usage basis. Uh, some are ongoing retainer or services basis, right? And you add all of those up to get after revenue. Costs are all over the place. You have fixed costs from rent, you have employee costs, you have variable costs, like the cost to produce the thing you're selling that go up when you sell, when you own more of those things or sell more of those things. So all these things for different businesses, the detailed version of that equation is different. For your business, you should know your equation. What it gets after is knowing your equation means you'll understand the connection between the things you do in the business and what happens on the number side, such that you can take an action in the business, look at your financial statements and say, I know where that is, right? I know if I sell another product that belongs on the revenue side, but also there's a cost there from commissions, right? And also there's a cost there from my salary, right? I know that if I increase my rent, it belongs in the rent column, right? And if you're not seeing the actions you're taking in the business, if on an everyday basis you're thinking, okay, I'm ordering this much more inventory this month, and I know, you know, some cash is going to go away, but I have goods in the warehouse, and you look at your financial statements and you don't see the impact of that, you know that you have to change up your reports, right? You're not seeing the way you think about your business in your reports. So that's sort of the first piece is understanding the foundation of your business and how it mechanically works in the numbers, even if it's just in theory. The second piece I said was key metrics. Key metrics sounds like a buzzword. It's not. I would narrow, I would narrow in on key metrics as being the numbers you watch to understand if your specific business is doing well or going off the rails. Basically, this means you are going to pick a small subset of things to track. For a lot of businesses, that's sales, right? That's total employee costs, maybe. That's conversion rate, the number of folks that decide to buy your product after hearing your sales pitch. You'll pick a couple of numbers.

Subscribers.

Subscribers, exactly. That's, that can be a great leading metric, maybe. Sitting down with your financial pro and helping them decide what those metrics should be that you want to watch is the other piece where you really want to be engaged to ensure you're watching the right stuff. So I'd say focusing on those 2 areas will, will get you pretty set.

So Lauren, have you seen a founder then become less capable of running the business after they hired a more sophisticated finance person?

I think it Can happen. Um, I do think that when you've done finance once and you've figured these things out once, there's kind of a lucky thing about it, which is that you never really lose it. I feel like learning some foundational lessons about finance as a business owner, if you do that first, it just kind of sticks with you. It doesn't really degrade. So if they have gotten those foundation— that fund— if they have gotten those fundamentals once, They're not really at risk of losing them with a bad finance support. They're more likely to just realize that the support they're getting isn't what they want. What I would say can happen is if they don't have the foundation at the beginning and they get someone who is a bad support in the finance function, things are going to go wrong, right? They're going to feel like they aren't getting the answers they seek, or they thought they were getting Making decisions based on information, but the information ended up not being very good information. It's not that their—

And herein comes—

Knowledge will atrophy.

You can't, yes, and you can't manage what you don't understand.

That's right. That's right.

We circle back to that.

You can't circle, yeah, you can't manage what you don't understand. But as someone passing off the finance function, your role as a CEO doesn't need to be to do, it just needs to be to understand. So as long as you understand good or bad finance manager, your own development should be fine, but your business might not be fine.

So have you seen a financial model, say, that became too clever for the business it was supposed to help?

For sure. When I'm looking at models, I'm often thinking about it just like someone would look at like a presentation of Who is this for? Because Excel is both a calculations machine, but it is also a presentation. It presents numbers. And it also is a bit like software where it has inputs and outputs and a way that it's meant to be used over time. Models built for folks who work in finance often look very different from models built by or for founders. The differences are a bit nuanced, actually. It's not just Overcomplicated versus not complicated, because yes, it's often the case that models for founders can be a little simpler, a little smaller, not as extreme, but at the same time, there's cases where models for founders are actually bigger because founders will more likely want to see the work, whereas a finance person doesn't need to see the work to see what's being calculated because they get it already. So it's less about the level of complexity and it's more just about the configuration matching the thought pattern of the person who's supposed to be using the model. So you're not just building a tool that works for the finance professional, you're building a piece of software for you to use. It just happens to be built in Excel. So the same things you'd think about if you were building like an intranet site for your team is like, what forms do you want in here? What do you want the login to look like? When you want data updated, where does that go? How do you make sure that people know what they're entering? Where are they going to look at this report or that report or this resource of information? It's the exact same thing, designing the way your Excel spreadsheet should look for the people who are going to manipulate it and review it.

So speaking of that, Lauren, you use this phrase growth without work. Explain what you mean by that.

So this comes from my financial modeling course. So I teach a financial modeling class most semesters at NYU for their entrepreneurship program. And this term came up because of a thing I was seeing in many models that were being built. What I was seeing was in a financial model, okay, stepping back, what is a financial model that I was teaching? The financial model I was teaching was for a startup that probably doesn't exist yet. So in this case, we're basically showing the nuts and bolts of how money will move through the business, how much revenue will come in, what kind of costs we'll incur, how much profit we'll eventually make, so on and so forth. And so the business doesn't exist yet, so we have to make a lot of guesses about all of these things. We have no idea how much sales will be or how high costs will actually be. All we can do is research and make educated guesses. So this tends to be a little easier on the cost side of things because you can go out and see how much things cost. How much does it cost to hire an engineer? How much does rent cost? So on. For revenue, this is really hard to do because who knows how many of these things I'm gonna sell? The business doesn't exist yet. I'll see when I open up shop, right? So how do we—

And it's not dependent on how much you invest in marketing either.

Well, here's the thing. It might be. That kind of gets down to the sales without work versus with work. In the business, the wrong way to do this in the model is to say, well, I think we're going to have a random number, $100,000 in sales in our first month. And then each month after that, we're going to increase sales by 5%.

Why?

I don't know. I don't have a better guess, right? That's the wrong way to do this. This is called sales without work or revenue without work because we're just putting in a random amount of money and the growth rate is really the sales without work. We're planning on increasing our sales, increasing our revenue, but how? I think the thing that breaks in people's brains before they've run a business is thinking that growth just happens. And it doesn't. At baseline, if you do nothing— John, if we know, yes. At baseline, if you do nothing in a business, sales tend to be flat or decline. You have to do something for them to grow. And that's the point. That's the work. The do something in the sense of a model typically costs you some money, right? You hire a salesperson, you improve your sales pitch to increase your conversion, You spend on marketing, which is, it seems like, oh, I can't just guarantee I'm going to spend on marketing and my sales will increase. That is true. And we say that in a context of describing why we have to make these investment decisions strategically and the fact that they're high risk and don't always work out. But en masse, when we're modeling probabilities for the future, it is probable if we spend more money on marketing, we will probably Get more sales. That's why we spend marketing dollars in the first place, right? It doesn't always work, but that's a thing we can do. And so it is reasonable to say if we spend X amount on marketing, we're going to expect to see this much more in sales, right? It's just connecting some costs, some effort to that increase in sales, because at the end of the day, we will be spending that money. And hopefully getting sales. But if we make a model where growth just happens and there's no work involved, what it sets us up to do is never question that false assumption of if we just open up shop, growth just happens, right?

Build it and they still won't come. That's, that's another, another line that many have shared. So which one of these points, Lauren, do some of the founders you've met tend to forget or not consider? Where the sales are coming from? Is it the marketing? Is it the cost of the extra production? What's the most overlooked part when people are considering growth without work?

I'd have to think about it a bit in just terms of having reviewed models, what people tend to leave out. There are probably some trends. So definitely marketing spend is one that people forget about or just assume that they won't spend because For them. You know, we talk so often about startups will brandish almost the fact that they really haven't spent on marketing. Oh, we've hit this number. We've barely even spent on marketing, as if it's a good thing. And it's funny because from an investor perspective or consultant perspective, what I hear in that is, oh, so you don't have a growth engine yet. Like, I want you to spend money and have it result in sales so that if I want you to have more sales, we could spend more money and they happen. If you aren't spending anything on marketing and sales are just coming. I don't like that. Sales are, sales are random and I have no idea if I could scale your company, right? So it's, it's not actually that much of a badge of honor to say you can do. But so this broken understanding of, oh, the best of the best don't have to spend on marketing. They'll, they'll forget to put in marketing or they just won't cuz they won't think they need it. So that's, that's a big trend. I would say when putting together a model, founders forget all sorts of other different things. Like marketing is probably like the big one they forget. Returns for retail businesses.

Mm-hmm.

Are a big one. Taxes, if you plan on being a profitable business, is a big one. In my modeling course, I used to have this sheet of paper where it's just like a list of all of the common costs that businesses had to kind of serve as your checklist against your own model to see like, am I leaving anything out? At the end of the day though, you should be fine with your model. The best way to check it at the end of the day will be once you actually start the business, you're just gonna go look at your financial statements. And see, okay, what did I miss, right? Because you'll be able to open up your P&L, your profit and loss statement.

And you'll be able to see a breakdown of what everything costs you.

Right, because in your financial model, you're actually trying to replicate that same profit and loss and guess at what it will be. So if your financial statement profit and loss doesn't match the financial statement of your business when you actually create one, then you want to bring them back to parity.

And that's what I was going to ask you next, because A forecast is going to be wrong anyway, by a small margin or by a large margin. So what makes a forecast genuinely useful?

So the forecast, I think something helpful when you're trying to do forecasting well, a step that people will often miss is defining what the forecasted number is as distinct from other numbers. And let's talk about revenue. Let's kind of isolate talking about revenue for a second, because quite honestly, Costs are a little more predictable. I mean, there's cloud compute and there's like AI, you know, token spend is now like a big exception, but eventually we'll be able to predict that too. So let's—

But otherwise rent and staff, uh, would be a fixed cost to a certain extent.

That's right. Pretty predictable. So let's think about revenue, cuz that truly feels like, oh my gosh, how am I going to calculate that? It doesn't feel like it's in your control. So first we wanna talk about what are we saying when we say forecast? Sometimes I think people confuse forecast with target, and they are 2 different numbers often. So your target is the number you give to your sales team. This is the amount of revenue you want to do, right? I wanna hit $5 million in deals by the end of this quarter, right? You can give that number to your sales team. That can be calculated, that can be pie in the sky, that can be your wishes, your hopes, and your dreams. But that is a target. That's what you're hoping for. Your forecast isn't a hope. Your forecast is what feels reasonable. Your hope with your forecast is your forecast will end up being just a little bit below what actually happens. Because what are you using your forecast to do? You're using your forecast to budget and make sure that your spending in the business doesn't ruin the business given how much money you'll be making into the future. That's its point, right? It's how much money will be coming in tomorrow so that I can pay—

And that's why you want the forecast to be below the actual.

Just a little, right? I mean, you, you don't, um, you would like it to just be accurate, but given the choice, especially in a small business, I'd rather it be a little under than a little over, right? Because I want to make sure that I'm not outspending my sales. How do you calculate this? Again, it kind of goes back to the discussion about sales without work. The way you calculate it is to look at the work. You look at what do I control in that whole sales chain, right? I can't necessarily control who buys from me, but there's a lot of things I do in creating those sales. I hire salespeople. I have a certain pitch that has a certain conversion rate. I call a certain number of leads, right? So what we can say is we can set some kind of benchmarks. Let's say right now. We are making $1 million a quarter and we have a single salesperson and they're calling maybe 10 leads a week. And 1% of those leads over time typically results in a customer. That doesn't sound like a great conversion rate or very many customers, but let's say that's what happens. If we want to increase sales, we can theorize about, okay, well, that's how much work we're doing now. How could we increase our work? If we call 20 leads every week instead, keeping everything the same, we should probably get double the sales, right?

But do you simply multiply it? Or for example, if you have 2 salespeople instead of just 1, it won't be 2%. It will maybe be 1.5 or 1.7.

Right. So this is, this is about testing assumptions. Because again, as we're moving through the business, what we're trying to do is do the best with the numbers that we currently have and continuously redefine our assumptions and the way that we're calculating these things. So you might in the outset with your current salespeople say, I think getting 2 salespeople, we're going to double this. What are the things that would make me think we're going to double this? One would be there's so many customers that are like in this pool, there's way more than enough for 2 salespeople. And so there's no reason why they should step on each other's toes. Conversion should be the same, right? But if instead you're in a highly competitive industry, you might say, you know what, there's, it might mean that there's fewer customers. They're kind of splitting sales. We want them to collaborate. We don't actually think this is going to double sales because of that effect. So we're going to have a more conservative projection on what's going to happen. Right? It's not that you're always going to get it exactly right. It's that you're trying as hard as you can to think about it all the way through. You're trying to break these situations into their metrics, because you see what we're talking about now, even talking about these 2 scenarios with the salespeople, we're talking in numbers right now. We're talking about salespeople, you know, we're talking about their deals, but these are numbers.

The same can be about content output and so many other parts of any business.

Right. But you see that we're having kind of a strategic conversation that now is based in the numbers, and both of us are thinking about the same math in our heads. Is conversion gonna go flat? Or actually, does conversion go down because 2 people is crowded and so their conversion will be less high?

We're talking about numbers. And the same can apply for marketing. You can double your marketing spend, but it doesn't mean that your sales will double.

That's right. It might not. There may be diminishing returns, but we're trying to understand all through, like why that's the case, right? And there's a lot of do it and test. I talk a lot in small businesses and startups how everything should be an experiment.

Yeah.

I used to teach this course at NYU called Test Everything, where it was basically a product-market fit class for very, very early-stage startups. And it was about taking your business idea and breaking it down into all of the, like, tens of Like almost 100 different assumptions that are inherent in that, that you could be testing for. So, for situations like this, where we're not sure the impact of this work, if we're really thoughtful about the work that we are doing, and we are specifically writing down our theory on what we think will be the impact, then later on, when the impact happens, we get to test our theory. And that's how you continually get better.

And how or where would a founder find this bandwidth? In between coming up with the product idea or the service idea, delivering it if it's the service, and all the other moving parts of a business. Granted, this is one of the most important parts of the business that one should pay attention to, but because it sometimes, or very often, it doesn't have immediate implications. It's 2, 3 months down the line where you start noticing things going wrong, and by that point it would be too late. How can you make sure that you pay enough attention to those numbers from the beginning? Is it building it into your business plan? Because I know if you seek investment, that is what money-wise investor will ask you, from the cost of acquisition of a new customer to your unit economics and so forth.

So you asked about time. When does a founder find time for this? I would Find the time in the earliest stage that you can, quite honestly, because what are you actually doing, right? The practice of having an ongoing finance function does not necessarily have to be the task of the founder. You don't have to sit there modeling all of your numbers in Excel and doing that day in and day out. You can hire that to do it for you. As we've already said, that's not the founder's job. The founder's job is to understand what's actually happening.

Mm-hmm.

And that understanding is resilient. You can learn it once and you'll kind of always know it as long as you keep integrating it into the way you think about the business. So what I encourage founders to do if they can is to build their very first financial model. It's the perfect time to do it. It's really early in the business. The business isn't complicated yet. It's the simplest it's ever going to be. The stakes are the lowest because you can be wildly wrong and have plenty of time to pivot. So it's kind of like This perfect learning experience to do it. Like when you very first start to go for like pre-seed or seed funding to build your first model, I would get into it there. I wouldn't use AI, I wouldn't use someone else to build the business. I wouldn't use a software program. I'd sit down in Excel and just do it yourself, which is what I've encouraged founders that I bump into to do.

You decided beforehand what failure would look like. Why?

Roost, I started a bit as an experiment, so I rage quit a previous job, um, and And decided that I wanted to prove that I could raise funding for something. My partner in Roost Homes was an architect, and he had this idea that these prefabricated home designs that they had built could potentially be a startup. And so, I sat down and studied it and studied home construction and looked at the market and decided, you know what, I've been looking for a business idea that I could go and get funded and start and be a founder. This one seems pretty good. Let's go do it. I think probably, you know, I'm a numbers-focused person, but also this was a really unique situation where I was evaluating the deal myself, almost as if an investor, right? Thinking about like, is this business likely to make it?

That's something that you did yourself, isn't it, Lauren? Because I want to get into Roost because there you did something that a lot of founders talk about, but rarely actually do, which is deciding beforehand what could be success. And what could be failure? Was that to have an exact amount of time in which you can decide and spend on this?

So with Roost, I was really in a unique situation. I was just coming off of another full-time role and really feeling like I wanted to run my own business for the first time. But in doing so, I was pretty clear on my definition of what that would be, the kind of business I would be happy to run. I wanted it to be either highly profitable or VC-backed. I wanted to be doing something that made the world a better place, and I wanted it to be in an area that I could feel passionate about and excited about. And so I had that kind of image in mind. I happened upon a partner and a business idea in the home construction industry, prefabricated homes to the Passive House standard, which meant they were very energy efficient and good for the environment. So in theory, it checked all 3 of my boxes.

Mm-hmm.

And I continued to push it forward. We got it a little bit of funding. We got the initial designs done. We seemed to have our first early customers that were excited to take on the project. We were getting great reviews for the design because the architect I worked with was very good. So all these things kind of were clicking into place, but then slowly I was realizing it wasn't really hitting the notes that I knew I wanted to hit. For one, my partner was Not so interested in taking on more venture money, which makes the VC path tough. The cash cycles for the construction industry are very long and very risky. I also, in terms of passion, I loved the building science behind it. I, you can't tell already, I'm a huge nerd. So I loved kind of learning about building science and how buildings heat and cool and all this sort of thing. But that wasn't my job. My job was selling houses, and I have never been interested in selling real estate or being a real estate agent. So that Really wasn't my thing. And then the nail in the coffin was realizing that the customer sentiment and the kind of product market fit, what people wanted, wasn't environmentally friendly homes. People said they wanted environmentally friendly homes and high efficiency homes, but in fact, when it came to spending their dollars, they didn't. They just wanted an, like an ADU on their property or a really big home.

And that's a trap so many founders can fall into in so many areas. People say one thing, but they actually do something totally different.

Exactly. Exactly. And so, you know, for some folks, and actually for me, I could have decided, you know what, that's okay. I'll just pivot into what customers do want. All the other pieces are kind of in place. I'll hire someone else to sell the homes and we'll just pivot into doing ADUs or big, beautiful custom homes or what have you. But were I to do so, I wouldn't be hitting the points, the checklist that I had in mind. This wasn't the business that I wanted to run. And so that was really what caused me to shut it down and focus on the business I run now, where I really have all of the aspects that I wanted in the beginning from that business in my own business, doing education and consulting, which is what I do now.

So, did you immediately accept it at the end of that summer, or did you start looking for maybe some reasons to keep it going? Because that, in my experience, that has been something that tore me internally, and I'm sure that many founders wrestle with it. You'll find a bit more money here. You'll beg, borrow, and steal from there. And you'll be able to buy yourself a bit more time until things start looking the way you hoped they would.

Yes. It's always a really hard decision to shut down a business. Roost is just the first business I shut down. I shut down another business later on in the past 7 years. So it's always hard. I took Not too much longer, I think, than I needed to, but I definitely knew the business needed to close a month or two before I actually closed it.

Mm-hmm.

And it's exactly the process that you describe. You really are sifting through all the options of things that you could do to not shut it down because it's only human. If you spend so much time putting something together, building the dream, you have to get excited about an idea like this to do it. I mean, if you think about what we do as founders to get a business going, it's kind of crazy. It's kind of like having kids. There's so much work involved that if an alien zoomed down and looked at us doing what we're doing from outside, they would probably say like, oh, these are irrational, crazy people. They're doing not the right thing. They should just go get a job. Like, the money's here. Why wouldn't you just do that? You have to be in love with it. It's the only rational reason to keep doing what you're doing. And that same love can make you continue to do it. Beyond the point where it's—

And be in denial. Yeah.

And be in denial. But I think that's okay. That's understandable. I do think that being tuned into the numbers can speed up the process because you can see the writing on the wall as opposed to closing your eyes and ignoring the writing on the wall. But I think it's not just the numbers. I think it's also your support system, the kinds of things that can help you not just run down the rabbit hole, are mentors who will tell you the truth, Friend groups who are peers who are kind of in the same business and understand what you're going through. Having those external touchpoints kept alive, which is a tall order when you're starting a business, it's hard to have a social life, but that social life, I think, becomes your mental lifeline.

So you now sit on the other side of this as the finance person founders hire. So I'm wondering, Lauren, how do you stop yourself becoming the person they depend on to understand their own company? Do you—

that's a great question. Actually, it speaks to a shift I've made in my own practice over the years where, again, nerd, so I'm always kind of observing, experimenting, and, and, and refining how I do things that I do. And early on in the business, I was taking on more of a, what people call now a fractional CFO role, which basically just means part-time CFO.

Mm-hmm.

And so, for 20 hours a week or 10 hours a week, you're working as a part-time employee, basically. Doing what a CFO would do or a finance department would do. Not all fractional CFOs do CFO work. Some of them do more accounting or more bookkeeping or what have you, but that's great as long as they're helping the business. And so that's how I started too. And what I realized was, you know, this execution stuff that I'm doing, this running the reports, this like managing the accounting team, you know, putting together the, the, um, the dashboard every week. It's not really where the value is. The value seems to be in the conversations that I'm having. That's really where the things are hitting, 'cause I've been a CFO for 4 years at that point.

Mm-hmm.

And so I slowly started to morph my practice into thinking about like, what are the really high value touchpoints I'm having with these folks? Teaching them how to model was a very high value touchpoint because it's something that's really hard to teach and can be frustrating for some folks, but I just love it. So that was really working well.

You can tell.

Yeah. Cool. I'm going to start blushing now. Helping them make strategic decisions while pulling in numbers was really valuable. A little bit on building financial reports and picking which metrics we should be using and kind of focusing attention. All of those areas were really high value, but I was realizing I can really kind of either outsource or help them find someone else to do a lot of the other things, the bookkeeping, the report writing, the accounting, all of these things. There's armies of folks who are really talented in those areas. And I can pull them in and get us a little more action. So now I really focus on advising and education.

I know you've been testing AI on financial work, and as it is with writing and reporting, the scary bit seems that it can give you something that looks completely believable or trustworthy or totally fine, but it's either logically or factually wrong. What's one of the most dangerous examples you've caught?

I have a whole saga that's ongoing trying to work with Excel using AI. Actually, it's funny, this exploration of the efficacy of AI and the safety around it is an area that I've started to study a lot recently. My first CFO role actually was 4 years with a security research company, and having a programmer background, I've even run a security research team. So, I'm really interested in kind of the guts of this thing and seeing how it's It's changing the quality of our work and changing our exposure to risk, specifically in the numbers game. I think I have— someone recently gave me a great quote and I'm trying to remember what it was, but Dia Sagar, who is the CFO of a company that produces comic books that turn into films, had this great line. We did a podcast, we did a panel with her and a lot of other media CFOs, and she was talking about how tough it was working with AI in finance. And what she said was, you know, we're finance. 80% isn't good enough for us. AI is a probabilistic function where it's right some of the time. And in finance, we cannot afford to be right some of the time. We have to be right all of the time. So 99%, 80%, it's a failing grade for us. So AI can help speed up our work somewhat, but because Accuracy and quality is so important in what we do, we have to check every single output. I found in my own work and from speaking with other folks in the finance function that there are some specific areas where AI has already proven really helpful, say in helping us pick recommended categorization of expenses in our financial software, right? Looking at a receipt and saying like, I think this goes under this category, but here you click it, right? So it can maybe save us some time in getting better recommendations. But in a lot of the other function, it introduces this layer of untrustworthiness in all of our outputs that as finance folks really can get in the way because something isn't done when it's done to 80% in the finance function. It's not done until it's 100%. So I think we are struggling a lot in that finance function, knowing if we're actually saving that time that we think we are. If it's the case we have to go back and redo work.

And that could be one of the false economies, which maybe it should make it on the balance sheet.

At the same time, you know, there is progress being made and it's ongoing, and finance is one of the really big areas of progress.

Yes, AI is so much better at counting now and basic addition, much better. A couple of years ago, even adding 10 numbers would yield incorrect results. So, let's say, though, that AI gives you a beautiful forecast in 30 seconds or a minute, and you use whichever is the latest model, Claude, GPT. By the way, which one do you use?

It depends on the task.

Okay. Quick breakdown so we can have some useful tips for people.

I think, first off, it is going to evolve over time. So, these aren't hard and fast rules. It's just who happens to have the most development at any one time. I tend to use the Quad plugin to work in Excel. That said, it's still not great and it can be very tricky to work with. So I'd proceed with caution, but I would say it's the best one for working in the spreadsheet so far.

But back to my main question was you trained your AI to know everything about your business or as much as it can. What would be the first thing you'd make me change or test before I trusted it?

The first thing I would probably do would be to build tests in it manually. Oftentimes in finance, what's really lovely is there's multiple ways of calculating stuff, right? We'll calculate something, let's say profit, for example, right? We could calculate profit by looking at all of the different revenue sources and subtracting all of the different cost sources in your model as you have modeled them with all of the drivers and assumptions that we've described, or you could look for the same month that your totals in your financial statement that match all of those assumptions and just pulling them in. Let's say in your model, you've built a model where those 2 things should equal each other. A test would test, do these equal each other, as a way of checking that all that driver logic was correct, right? This is just one example, but writing tests is a little hard. You have to look at what the sheet is calculating and say, what are 2 totals that should match, or what should this do if it's working properly? So it's hard to be specific here. If, if you could, so you'd either build a test, you'd look at the, the, the spreadsheet and say, what is a test I can build here? Otherwise, you could look through and simply click around to see, do I believe all of the ways it's calculated? So as a manual auditor who does this more on a casual basis, not as a cell-by-cell basis, when someone's built a model, I cannot just follow their cells. I'm also kind of following their brain. I see how they're calculating something, and because I've been doing this for years, I can say, oh, I kind of see what they're doing. If they're doing it this way, I bet they made this mistake over— oh, yep, they did make this mistake over here. This is a conversation we need to have. So I have this sort of extra sense of what's going on that can help me work with a modeler and ensure that there's fewer mistakes.

Mm-hmm.

And then pair it with tests. But with AI, they don't have that reasonable human logic to follow. And so it can make mistakes in totally weird places you would never predict, which again makes it really hard to find all the potential mistakes it might be making. Pair this with Excel models are a tough problem for it to solve because the context required for that AI to do things properly is really big because models are huge. They're also not just the numbers, it's the display, it's the colors, it's the position. There's a lot of factors and they have fewer Excel models to build into their training data than they do software programs. So they also don't have as much data to do their pattern matching on. So it's just a tough area as well for the AI to consistently do well. Despite that, it's continuing to get better, but it's still not perfect. And if it's not perfect and it's not predictable where it's gonna go wrong, it's really hard to use.

And you need to know what you're doing because that's, that's my next question. Whether it's AI or another person doing the analysis, what does the founder still need to understand themselves before making the decision?

I think the most foundational thing that the founder needs to understand when they're doing anything in Excel is what is your goal here? Like, what are you trying to find out with this thing? If you are simply trying to create a report for your investors and it's just a run-of-the-mill report, like that they just always want to see, then your kind of goal is to get to that template. But if you want to create some kind of financial model to give you an answer, then you want to really be thinking about like, what is this question I'm trying to answer and what is the data I need to To see that will make me feel satisfied in getting there. If that's where you start, it might be the case that you need to do way less modeling than you initially thought in getting there. You might say, "Oh, I need to understand the profit of my company," and then think you have to build a huge model that's going to you know incorporate all of your business lines and all of your costs and da da da da. When in fact, if all you want to know is the profit because you want to be able to predict. your cash next quarter, you might be able to just use, if you have consistent costs and reasonably consistent revenues, the big picture numbers of your totals, and you barely need a model at all. You just need to look at what's happened in the past, add the totals, and project into the future the same results. So, it's really being clear what you're trying to decide, what you're trying to know before you get in there. And what's the biggest difference between a service-based business versus a product-based In terms of the financial model, the biggest difference would be the things you're probably looking to track. Service businesses end up being very much about capacity. Again, I mentioned in service businesses, you're trying to hit that balance of the amount of money coming in and how many people you have on staff. So you're constantly trying to figure out, do I have enough people? Do I have enough work? And building models for that business is often about giving you really good fidelity in, in understanding that. And if you've got all of your reports set up the way you would in a product business, you're not going to see any of that information because you're just going to have a big salaries total line. And that doesn't tell you anything about capacity to serve. So you need to have more reports beyond just the income statement talking about hours or days available.

Mm-hmm.

You might also need to think about things in terms of per project, if you're wanting to look at different profitability per project, if that's a thing for you.

Well, that gives a lot of thinking space there, but I'm gonna try and wrap up our discussion with a more pointed question, Lauren, because I'm wondering after everything you've seen, what would you say is a decision that founders most often make before they properly understand the numbers? Underneath it. It could be a cut, it could be an increase, but that gives you an idea of where I'm angling.

A decision they make before they understand the numbers.

They understand the numbers underneath it.

Probably hiring.

So a basic one, but also with big implications.

Yeah. So I'd say, I would say it's, it depends. It's hiring. Maybe there's 2 of the most common that I'm seeing. Hiring or new products, I'd say are the 2. that I see get made wrong most often, and it's because of the hidden costs involved. So for hiring, oftentimes, especially if it's early days and you're not used to hiring people, you might underappreciate all the costs that come alongside hiring beyond just that salary number.

Yeah.

And also—

Guilty.

You might, right? So there, it's not just the salary, it's the benefits, it's the computer, it's The tax, the subscription, the transport, et cetera. The compliance, all of the HR stuff, the fact that you're more likely to get sued now. There's like all of this stuff, right? Exposes, extends your, your liability, even just in the projects that you do. All of these things are extra costs. And if you look at it and you just say, oh, that's $100K, great, I can afford $100K, good. You're gonna be very disappointed when you discover actually for your unique business, and especially cuz it's the first time hire, so it's the first time you're doing all of this. In total, it ended up being more like $200K.

Yeah, I was about to say 40% more, but you used a more realistic figure. Yes.

Right. So eventually 40% more, but the first hire, when you're kicking off all these services for the very, very first time, and you've had to hire an HR consultant for all the— anyway, so it can be more. The other thing that will come into play with hiring decisions often is the cash cycle. So if this is one of the first big investments you're making, you might crash into this idea that often you do the work before you get paid. So this is a good example for— this happens for product businesses too, but a good example is in services businesses where let's say you are a consulting company. You typically will do the work and then submit an invoice and then you get paid 30 days after, right? So you need the body in the room to do the work on month 1. You invoice at the end of month 1, the customer receives the invoice and says, ah, isn't this invoice nice? I'm going to take 30 days to pay it. So at the end of month 2, you finally get paid. Right? But you had to pay that employee.

Everything upfront.

Upfront. So you need enough cash not just to pay the employee, but also to pay them without getting paid for 2 months. So it's also about, they're gonna be more expensive than you think.

Minimum, because larger companies use 90 days.

Right. Or they don't pay on time or they never pay, right? You need a bigger cash cushion than you think to support that employee while you're waiting for the cash to come in. And add to this, you probably can't put them on a project on day 1. You probably have to train them for a couple of months. So, you gotta think about the timeline for what it's going to take for them to translate to cash in the door. So, that's one of the big ones I would say that happens again and again. With spinning out a new product, it's really just about that well-made plans are kind of made to be smashed in half, and spinning up anything new is typically going to cost more than you think it does. It's in a less predictable way. It depends on the project, but it's helpful to have some contingency cash for any new investment that you don't already have a lot of reps under your belt.

Okay. Then this will be my final question because so many businesses and so many startups live hand to mouth every month and pretty much earn what they spend that month by the order of a day, if not less, if not hours. How can you get to build a good amount of cash reserve, 2, 3 months in a good scenario, especially when you're a startup or a small business and you want to grow and invest in people, products, software, et cetera?

It can be so tough, um, to build up a cash cushion. I think, you know, there's not a lot of good, easy answers here. People will kind of give you the financial diligence thing, but it's funny, you see so many kind of finance influencers for personal finance telling you like, this is how you save money, right? You have to think about like, just put the money in the bank upfront and then just don't spend it. Or like, yep, stop buying that coffee. And at the end of the day, you look at it and you're like, I mean, if you're just not making enough money to cover the expenses of your life, you're just not going to have money. Like, that's how it is, right? It's math. Skimp and save and do this so much. It really comes down to, is the thing that you're selling making enough money to support a business? Any business, right? A business, the smallest unit of a business is still expensive. So you need to be making a certain threshold of money for it to work out. Otherwise you're just losing money. So I think the first kind of more theoretical thing to do is in the business understanding, is this a money— is this a business that can make money?

Mm-hmm.

Which is to say, and this can happen building a financial model, what is the revenue number I would need to hit for this to be profitable? And is that revenue number at all feasible over time to sustain, right?

And what would that make the price of my product and/or service in order to reach that?

That's right. Often we'll talk about, I think a lot of people mistake early stage financial models as a forecast when in fact In fact, the earliest stage model before the business exists yet isn't a forecast, it's a feasibility study. So, doing that feasibility study on your business, basically what you're saying is these assumptions, they're not wild guesses, they're reasonable assumptions of what the revenues and costs will be. And at the end of the day, the model's purpose is to tell you, is this a stupid business, right? Is this a business that's just never going to make enough money to support itself, or is this a business where— Yeah, the money that it will make will greatly exceed the minimal cost of running it. And if you're in the first bucket where it's just going to be a business that really would have to really struggle, um, and is only ever going to make a couple percentage points of profit, you got to ask yourself, is that a business you want to run? So that's what I would, rather than thinking about like how much I could save or ways to like gin up the revenues or this sort of thing, at the end of the day, as a finance person, the most helpful thing I can say is the very beginning deciding Is this a business that is set up to make money? Is there a way that this can be a profitable business?

And there's always the variable of you don't know realistically how much product or service clients you could have or sell in a particular amount of time.

It's true, but you could design it, right? I think oftentimes in my modeling classes, when folks will say something is impossible to forecast. I can fix that problem by just asking them to try. So, because a lot of times our brain kind of stops. We think about trying to forecast something that just doesn't feel like, well, I couldn't know that exactly. And you kind of have to adjust and be like, well, no, no, no, you don't have— exactly is too high a bar. But if you had to, gun to your head, say a number, how would you come up with it? What would you do? We actually, it comes from, I was a management consultant for a couple of years for one of the big consulting companies. And in those interviews, you do this market sizing exercise where they ask you to say, how many bees are there in Tanzania? And you don't know, but there's other things you might know to help you come up with it. And they're not testing you for the actual number. They're testing you for how you think about the problem, thinking about, okay, well, maybe I understand how big that place is. Maybe I understand where bees are located, whether they're in warm places or cool places. Maybe I think about Bees as being related to how many flowers are in a place, and I can think about how many flowers are in a place by thinking about what percentage of the landmass is hospitable, right? So there's all these mechanisms that could hint towards the presence of bees in a particular place. That's what you're trying to do when you're trying to figure out a forecast.

So it's not a wild guess, it's an educated guess.

Right. It's a, it's a guess based on factors that are knowable.

I think the key lesson then here, Lauren, would be to leave with people tuning into this episode. If you haven't started yet, you need the feasibility study and the financial model, which doubles up as both. If you just started, then you still need to do that if you haven't done it. And if you're underway in whatever part of your business you are, running it again or adjusting it will totally pay off and tell you which direction you're going.

It always pays off to understand your business. I think I tell founders who are just getting started, who feel annoyed by the fact that they have to build a model, that as a founder, the thing you have to adjust to when you go from being an employee to a founder is how much time you're gonna waste. As an employee, you are being graded on the efficiency of every minute and being really good at your job. And if you get something wrong, you get fired. As a founder, you get everything wrong until you do like one thing right, right?

Mm-hmm.

You're, you're spending all like trying to do like all these marketing things and nothing will work, and then you find one and it works, right? You try to hire people and you work with all those people that don't, that work for you. And then finally you find it. You waste so much time. You waste so much money. Learning the finance of your business is never a waste of time. It is one of the most true ROI, return on investment, ways that you can spend your time in a business. It will absolutely make you a stronger founder. It will help your business. There's no way that any time spent learning in this area is not going to be something you're happy you did later on. And what a blessing that is as a founder to have one thing that you know is worth it.

And I'll let this be your final word of this episode. Preach. Amen. And thank you for sharing all these insights.

Thank you so much for having me. It was a very fun conversation. I really appreciate it.

Thanks for tuning in all the way to the That's the end of this episode. If you enjoyed it, please share it with someone you think would get value from it. And don't forget to subscribe on YouTube, Spotify, or Apple Podcasts so you never miss an episode. For the best way to stay in the loop, head to millennialmasters.net. That's where you'll get all the latest features and new episodes straight to your inbox every week. Catch you next week. Bye.