financial model

Business Modeling for Engineers

So, you have a whiz-bang idea huh?  Working on that “business plan”?  Well, you are going to need a BUSINESS MODEL to go with that idea… and this little post will help you get started.   You can also download this little Excel .xlxs file I made that has the bare-bones of a Business Model for you.

A Revenue Model:

You are going to need a model for revenue.  Revenue is the top-line, what people pay you.  To create a model follow these simple steps:

  1. Decide the “Value” of what you are selling (Product or Service).. in terms of your TARGET MARKET AUDIENCE.
  2. Set a “Price” for your product that is less than the Value:
    1. this might be recurring (e.g. monthly) or one-time (transnational)
    2. Value has NOTHING to do with COST. (ignore cost).
    3. Value can be calculated as either:
      1. the price of an alternative +/- some premium (because yours is better/worse)
      2. the sum of ‘savings’ that a user experiences with your product/service
      3. the sum of ‘benefits’ that a user gets, in terms of a number of alternative products/services.
  3. Now, figure out a Quantity you think you can sell.
    1. Bottoms-up: Use some model of Customer Acquistion (like impressions->clicks->sales)
    2. or Tops-down: Use some model of Target Market Size (like 1% market penetration in year 1 of your target market).
  4. Now, simply multiply the monthly Quantity * the Price, and you have a Revenue Model.
  5. Show some scale/growth in subsequent months according to some formula (like 5% annual growth or as a complex model with advertising causing growth)

A Cost Model:

Next, you are going to need a cost model simply:
  1. Calculate the cost per unit by summing the cost of it’s parts + the sum of the cost of the labor to ‘produce it’ (or in the case of a service, the labor cost of providing the service).
  2. Multiply the monthly Quantity (above) with the monthly Cost, to get Monthly Costs.
  3. NOTE: COSTS ARE NOT EXPENSES!!!  Costs, are purely the VARIABLE costs that it takes to produce a good/provide a service.

Gross Profit:

   This is simply Revenue – Costs

Expenses:

Estimate monthly expenses for operating the business….  here’s a rule of thumb:
  1. Use $4000 for rent, $2000 for Legal, $1000 for Misc.  (or do a better job than me at estimating your actual costs!)
  2. Use at least 5% of Revenue as a Marketing Allotment (or do a better job than me at estimating your marketing expenses).
  3. Scale expenses yearly to increase by 10%.
  4. Any employees you have are also here as an expense. (yourself for example).
  5. Use the monthly salary * 1.17 (for benefits/taxes)

Net Income:

Net Income is simply Revenue – Costs – Expenses.
(it gets more complex if you have loans and other stuff… but for now this is a simple model).

Cash:

Take your starting cash, then add your Net Income to it each month.
(this is not precise at all, but also not a bad model).

Done.  You have a model.

Enjoy!  Feedback/suggestions welcome!

* photo courtesy of: http://www.geograph.org.uk/photo/2824035