Building a startup is a lot about product and usability and all the stuff you’ve been reading about. But mostly it is about Math. I’m presenting a really simple way to understand the basic equations in a business and how it’s different in the startup phase and in the mature phase. Instead of using business terms, I’ve used intuitive-speak. I hope you find this useful.
This is the God-equation of ALL businesses:
Profit = Revenue – (Into_Product + Also_Product + Mkt)
Revenue = what you earn. All of what you earn. It is the sum total of all money coming in because of what you’ve sold (product or service). Investment is NOT revenue. Forget investment for now.
Into_Product = the cost of what goes into the product. Like, actually into it. Like for instance, if you are a bakery, then the cost of all the flour is added to Into_P.
Also_Product = the other costs you incur in making the product, but these things don’t go “into” the product. Like you need to pay for electricity and you need to pay a salary to your baker. But charged electrons and your baker certainly don’t go into your cake, or atleast, I hope they don’t. If you paid a bomb for the oven (or any other asset), then divide it by 5 and add the result to Also_Product. This is your depreciated cost of the over for 1 year.
Mkt = the cost of sales & marketing.
Now, consider these graphs:
Into_P grows proportional to revenue. Also_P grows step-wise-proportional to revenue. And Mkt is a huge untamed cost in a startup but gets tamed as we go along in a sort of an exponential decay.
To rephrase this, it is upon the entrepreneur to
a) Spend on Mkt so that revenue grows. It doesn’t grow on its own.
b) As revenue grows, make Into_P proportional to revenue. It doesn’t happen on its own.
c) As revenue grows, make Also_P step-wise proportional to revenue. It doesn’t happen on its own.
d) Spend heavily on Mkt in the beginning, but tame it quickly. It doesn’t happen on its own.
Product_Margin = { Revenue – (Into_Product + Also_Product) } / Revenue
Profit_Margin = { Revenue – (Into_Product + Also_Product + Mkt) } / Revenue
Whether you are a startup of a running business, your Product_Margin should be positive (except at the very beginning). However, Profit_Margin is positive only when a startup is appropriately scaled up. Hence, scaling up is really all about reaching the scale where you have a healthy Profit_margin. And Investment is that amount of money you need to incur losses till you reach scale. Break-even is when all your net losses are recovered.
