Adding up the Numbers

Adding up the Numbers

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Often, business plans are written by entrepreneurs with great ideas and promising products but only a vague idea of the size of the market or how many middlemen they’re going to have to cut in along the way. As a result, the sales projections that they come up with are often wildly optimistic – R100 million the first year, R200 million the second year and R500 million the third – and the profits are so enormous that an investor might wonder why the company needs to raise any capital at all. And yet these entrepreneurs wonder why their business plans aren’t getting funded.

The reality is that no matter how passionately you believe in your business, you’ve got to make the numbers work before you can turn your entrepreneurial dream into the reality of a profitable and scalable business. While nobody has a crystal ball that can predict the future, a good financial model will help you understand the key drivers that make your business tick and help you avoid the kind of problems that can sink your venture before it even launches. Here are three common business mistakes that a good financial model can catch.

Critical mass

Your business must hit critical mass before it can reach profitability. Any business that relies on the power of database marketing requires its database to grow to a certain size before other members will be interested in joining. And that’s the catch: Until the database is large enough to attract a significant number of members, few people will want to join. Therefore, database marketers must spend money to acquire customers without knowing whether their investment will ever pay off.

The solution: Give channel partners (trade associations, clubs, affiliate web sites) a piece of the action in return for helping to lower the cost of customer acquisition.

Customer aquisition costs

The cost of customer acquisition is too high for your company to ever become profitable. As many dot coms discovered ten years ago, you can’t always spend your way to profitability. While laying out millions for advertising may be the quickest way to pump up revenue, it’s a money-losing strategy if your company can’t turn that money into life-time customer value.

The solution: Test, measure and test again. Only when you’ve done enough testing to figure out how to create a positive arbitrage between how much you pay to acquire the customer and how much revenue the customer is likely to generate should you throw big money at a roll-out campaign.

Reseller channel challenge

Your company has no reseller channel. Because it’s difficult and time-consuming to acquire customers, most new companies find it easier to break into a market by tapping into a network of manufacturers’ reps, agents, brokers and other third-party resellers. By contrast, companies that enter a market without an existing reseller channel often struggle to survive, alternating between feast and famine.

The solution: Make a list of potential channel partners before you start your business and ask them if they’d be willing to send some business your way.

Rosalind Resnick
Rosalind Resnick is the founder and CEO of consulting firm that advises startups and small businesses.