Financial Modeling Part 3 – Modeling Your Expenses
Transcript
Welcome back. Last time we talked about financial modeling. We used the financial model to understand the impact of raising prices and what happens when customers churn faster because the bar is higher for them, their expectations are higher. And what that allowed us to do was craft a test. You see, we had this base case where our price was $29.99 a month. We had 4% churn. We said, if we go to $39.99 a month, how much churn can we get to?
we accept while it's still a net positive to the company we came to the conclusion that cutoff was
just over seven percent so we could run an a b test our existing customers at 29.99 and 4 churn
we raise the price to 39.99 if churn is seven percent or below the test is positive that's
awesome if the churn is eight percent or greater that's negative we're we're in the uh we're in the
red and so now we've created an a b test with a binary outcome positive or negative well it's
great to think about increased revenue but most entrepreneurs don't think enough about increased
expenses they don't spend enough now wait before you go around yelling that troy is telling people
to spend more money because that's not the case only spend enough on the right things and of course
the right thing to spend money on is customer acquisition so let's take a look at what happens
when we increase our spend in customer acquisition let's look at the model so in the model to orient
you you'll see here in the bottom right hand corner of the annual cash flow that we have half
a million dollars in the bank and then when we go to our assumptions tab you'll see that we are
spending a steady state of ten thousand dollars in sem or google spend and ten thousand dollars a
month in facebook spend i have these two tied together so that when i change one the other one
changes just to make life simpler so the question is what happens if we double our spend instead of
20 000 a month in total we're going to spend 40 000 a month in total over five years that's roughly
1.2 million dollars of extra spend what are we going to get for it and we'll define what we get
for it as this number cash in the bank at the end of five years and so i ask you what do you think
is going to happen when i type twenty thousand dollars and i hit the enter key we'll of course
spend a bunch more but will we make enough more from our customers to offset it and you can see
is i hit enter that boom we actually made an additional half a million dollars so by spending
more money in marketing we not only paid back that marketing spend but we got more money back
and we're in a better position with over a million dollars in the bank instead of 500 000.
that's awesome there's a saying if some is good more must be better so let's do more what happens
if we go to forty thousand dollars a month so what do you think is going to happen when you
forty thousand dollars a month of course my cash in the bank is going to go up right
and it did we can all see it here we're now at 2.25 million dollars in cash in the bank and that is
phenomenal but what do you see that's wrong pause until you see it well hopefully you figured it out
by now the 2.25 million is a great outcome except for one problem and the problem is that in year
one we had negative cash we died remember what we said cash is to a business like oxygen is to a
human if you're without it for more than two minutes you're dead we were two hundred thousand
dollars in the hole this business never lived to see the day where it would get to 220 2.25 million
dollars in cash ah so what happened here we spent too much in marketing too quickly now there are a
couple ways we could solve for this the real world way is we'd go in and we take a look at the traffic
detail tab that i have and see how that spend works and you can see that i have just copied
that forty thousand dollars a reference that forty thousand dollars in my steady state of how much
i'm spending each month well that's not reality you're not going to spend the same amount in
marketing in month five that you are in month 55. so more likely is and i've made that green to
demonstrate that that is an input or an assumption that that assumption would be a variable it would
be a function it might be something like a maximum of forty thousand dollars but not to exceed 25
of the cash on hand however you want to do it but it should be a variable over time however
there's something else that we could do that would be easier and will demonstrate something
else about the model. And that is, if we take a look at our model, sure, we ran out of cash. We
were negative 207. But if you look a couple cells above, we had raised a million dollars that year.
Why don't we just raise a little more? Why don't we just raise an extra $500,000 so that we have
some buffer? Well, we could do that. And that's really simple to do in the model because I have
assumption and the assumption is how much do we raise here it is and i can change this to one five
oh oh oh oh boom we just did it we're no longer out of money and we got a bunch of cash at the
end of the day but we just increased our dilution by 50 instead of raising a million we raised a
million five so i ask you entrepreneurs would you rather take 50 more dilution in your first round
and end up with more cash or hang on to a bigger chunk of the pie and have a little less cash.
The model will tell us the answer and that will come in the next session.
You’ve just raised a bunch of money! Congrats! Now how much should you be spending? Last time we talked about how to use the financial model to understand the impact of raising prices and customer churn. In today’s video we are digging into how much money you should be spending and how it will effect your business in the future. What happens if you double or even triple your spend next year? Will your business thrive or shut its doors?
Originally published on the MATH Venture Partners blog.