“I have added a few Revenue drivers in the forecast model. Just take a look at the financial model and comment on it.”
Revenue Is (Almost) Everything
When my boss finished the first draft of the forecast model, he shared that file to me and hoped that I could take a look and see if there is anything wrong. Based on that forecast model, I could see that my boss has paid more attention on the Revenue side.
“Revenue is the most important part of our business. Our investors decided to invest in our business because they could foresee an exponential growth of Revenue in our business. That’s why I have added a few Revenue drivers in this model so as to forecast the Revenue growth as accurate as possible.” my boss shared his thought to me.
To him, the most important figures in the business are actually 1) Revenue, 2) Cost of Goods Sold, 3) Gross Profit Margin, and 4) EBITDA. All of them are from Income Statement. He told me that investors were more interested in Income Statement than in Balance Sheet. It is because all they cared about was whether the business could make money or not.
In fact, we can see a lot of startups in the market, offering different kind of products or services. As those startups are related to technology, they tend to have high valuation but no profit in the first few years. Their investors use Revenue multiples as the main valuation method to value the businesses. That’s why Revenue plays a very important role in those businesses.
My current employer is one of the most anticipating startups in HK. Therefore, the investors are concerned about the Revenue growth of the company. That is why my boss has been paying more attention on the Revenue side when creating the forecast model.
Based on that forecast model, I have learnt a lot on the Revenue drivers in the forecast model. Today I am going to share what I have learnt from that model – the 5 key Revenue Drivers.
1st Revenue Driver: Capacity & Cost of Goods Sold (COGS)
In Accounting, Cost of Goods Sold means the direct cost that incurred when we produce the product or render the service that can earn the Revenue.
Take my current employer as an example. My current employer has rented a lot of warehouses for the storage business. The more the warehouse we rent, the more the space we got for the business and the more the service we can render to our customer. Hence, the more the Revenue we can earn. Here, the rent of warehouses is the COGS in our business.
However, we cannot rent excessive warehouse when we only have small no. of customers. That will lead to a waste of resources and will not help boost the Revenue. In order to know the appropriate space of warehouse for the business, we need to do a lot of analysis.
In other words, the more COGS we incurred, the higher the Revenue we can earn until certain level.
2nd Revenue Driver: Size of Team (Direct Labour)
This is similar to the first point. Sometimes we need a bigger team to earn more Revenue.
Take my current employer as an example again. One of the subsidiaries of my current employer is a relocation company which offers house moving services. My boss always wants to triple the Revenue in 2 years but in vain. It is because the team can only take up to 60 orders at most per month at this moment.
In other words, the manpower becomes the bottleneck of the process.
This happens when the company is still in traditional businesses where manpower is one of the key factors that deliver the products or render the services to the customer. As nowadays the machines still cannot completely replace manpower, we still need to face this bottleneck. Hence, we always need to pay attention to the no. of manpower we have.
In Accounting, these kind of manpower is called direct labour that is directly related to the Revenue earned.
In general, the larger the size of the team (direct labour), the more the Revenue we can earn.
3rd Revenue Driver: Order Frequency
If we are running restaurants and earn $50 per order on average, we can earn $500 per day if we can get 10 orders per day, and $5,000 per day if we can get 100 orders per day. The frequency of order is proportional to the Revenue we can earn until certain level.
However, it is not simply about the orders. We need to make sure that we have sufficient resources to finish the orders.
Let’s take catering business as an example. What if we only have one chef in our restaurant? He / she can definitely handle 10 orders per day, but he / she might be a bit tired if he / she needs to handle 100 orders per day. If he / she needs to handle 1,000 orders per day, he / she will be impossible to finish all the order. This leads to a bottleneck which in turn results in inefficiencies.
In order words, order frequency is one of the key Revenue drivers but we should make sure there is sufficient resources to deal with any bottleneck occurred.
4th Revenue Driver: Average Selling Price
Putting aside whether the customers are willing to pay, the higher the prices we set for our products or services, the higher Revenue we can earn.
That is why Apple has earned so much Revenue from its products. Let’s take iphone as an example, the lowest price of iphone is no iphone SE 2, which is around USD 399. If we want to buy iphone XR, 11 or even 12, we need to pay at least USD 499, USD 599 & USD 799 respectively. If we only consider these 4 models, the average selling price of iphone is around USD 574, which seems to be higher than other Android phones.
However, it is not just simply setting higher price and waiting for the money coming in. The price should be within the expectation of the customers, otherwise they will not pay the money so easily.
In other words, it is all about the value that the company can delivery via the products or the services. The customers are willing to pay premium for iphone only because they can enjoy the value from the iphone, eg, excellent user experience, security, design, etc.
Therefore, average selling price might be one of the Revenue drivers, but it is limited to the value that the customers can obtain via the products or services.
5th Revenue Driver: Marketing & No. of Customers
Marketing expenses are one of the significant expenses in running business which might be able to boost the Revenue, or not. It all depends on whether the Marketing Strategies are placed correctly or not.
The higher the marketing expenses do not mean the higher the Revenue earned. The key here is to make sure the Marketing expenses are spent in a way that the target customers can be reached. If we are selling premium products but we put our advertisement in low income area, we can never attract more customers.
This is what I understand about Google Ads. Google ads helps the companies place the right advertisements to the right customers based on the browsing practice of the customers. If their AI finds that one customer keep looking for similar products or services as ours, Google will automatically place our advertisements to the websites that customers would visit.
By spending the Marketing expenses in the right place, we can attract more targeted customers to buy our products or services, and earn more Revenue than before.
Conclusion
To conclude, there are always so many ways to make profit: to reduce the Cost and to increase the Revenue. However, there is always limitation of Cost reduction. We need to focus on Revenue if we want to increase the profit. Hence, it is useful to consider these 5 key Revenue drivers when running businesses:
- 1st Revenue Driver: Capacity & Cost of Goods Sold (COGS)
- 2nd Revenue Driver: Size of Team (Direct Labour)
- 3rd Revenue Driver: Order Frequency
- 4th Revenue Driver: Average Selling Price
- 5th Revenue Driver: Marketing & No. of Customers
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If you have any questions or have anything things to share, or you would like to be a partner authors with me, you can reach out to me via email learning@iamdelusionman.com.
Besides, if you want to know more about what I have learnt from other successful people, you can click the below link. This could the one of the life-changing articles for you:
