Designing the financial model (in a real-world sense, not a spreadsheet sense) of your business is worth every minute that you can dedicate to it. We should craft the financial model of our business with as much care as a fine architect and craftsman would spend on their own house. Too often, we settle for models of how the business was run before or how other people in our industry do things rather than proactively designing our business to maximize its potential.
To help you think about the financial model of your business, I want to try an experiment that I call “The Perfect Financial Business” — this business is so perfect that it does not exist in the real world. However, the idea is to compare your business with perfection to identify the areas where your business is very strong and those areas where it is weak compared to The Perfect Financial Business. It does not necessarily follow that you should work to improve your weakness or deepen your strength. It may be that a weakness of your industry/company compared to the Perfect Financial Business is helping you because you can handle that weakness better than other firms. More on this later. For now, here is an overview of the areas that I want to cover in describing the Perfect Financial Business.
- Revenue — recurring revenue or repeat customers versus one-time customers
- Revenue — customer concentration
- Gross Margin — higher is better than lower
- Shipping and Transportation
- Working Capital
- Fixed Assets
- S, G & A expenses — operating leverage
Thus, the Perfect Financial Business has recurring revenue customers with no large customers, each incremental sale does not have much incremental cost, there is no shipping costs/risk, there is no or low inventory, the business receives payment from its customers before it pays its vendors, has no or a low amount of fixed assets, and does not have to add overhead as it increases revenue.
My plan is to explore each of these in later posts.