10.3 Revenue and Cost Drivers

What do revenue models influence?

Revenue models influence who your customers are and how you reach them.

Although choosing and establishing your revenue model is an important step, it is equally important to have what?

to have a deep understanding of what is driving both your revenue and your cost, in order to generate as much value (profit) as possible for your company.

Four Key Revenue Drivers

1. customers

2. frequency

3. selling process

4. price

What is the first key revenue driver?

customers

What is the second key revenue driver?

frequency

What is the third key revenue driver?

selling process

What is the fourth key revenue driver?

price

But how do you determine your revenue drivers when your business hasn’t even begun yet?

By getting out of the building! Actively testing your assumptions and hypotheses is the best way of figuring out the underlying factors that will drive revenue for your business

Understanding the factors that drive costs are just as important as your key revenue drivers. True or false?

true

When it comes to cost drivers, two different types of costs should be taken into consideration:

COGS and operating expenses

Cost of Goods Sold

the direct cost of producing a product

Operating Expenses

the costs of running your business, including your rent, utilities, administration, marketing/advertising, employee salaries, and so forth

COGS and operating expenses are both what?

expenses

Example of COGS

The cost is in how much money it takes to produce each T-shirt: the material, the design, the manufacturing, the packaging, and so on.

When does COGS occur?

when a sale takes place

What does lowering COGS mean?

you could potentially sell your at a lower price to your customers.

However, there needs to be a balance between reducing your costs and satisfying your customer.

In other words, you would need to ensure that you are not devaluing your product to the extent that it would reduce your customers’ willingness to buy it at all.

Why are operating expenses more difficult?

These kinds of expenses are more difficult to reduce. Cutting operating expenses can yield beneficial short-term gains, but it does not always work in the long term.

Examples of Operating Expenses

Rent
Utilities
Administration
Marketing/Advertising
Salaries
Accounting
Insurance
Transportation
Taxes
Legal fees
Office supplies
Benefits

What is one way to cut operating expenses?

If you move your store to a cheaper but less popular location to save on rent, you will save more money. However, over time you might lose out on revenue because the new location might not attract as many customers—or the right kind of customers—compared to the more expensive location.

What is another way to decrease operating expenses?

Another way to decrease operating costs is to reduce employee salaries or reduce the number of employees altogether, which has an immediate positive effect on the bottom line. However, it also might damage customer relationships if there aren’t enough skilled, knowledgeable staff to help drive sales.

You need to strike the right balance in the areas of COGS and operating expenses.

True

What do you use to measure the revenue generated and your company’s profitability?

income statement or profit and loss statement

Income Statement

a financial report that shows revenue, expenses, and profit for a period of time, typically a month, quarter, or year. It subtracts the COGS and expenses (administrative, marketing, research, and other operating expenses) from the total revenue to give you a net income figure, which will be either a profit or a loss.

What is the income statement also called?

profit and loss statement

Every entrepreneur needs to develop what?

pro forma income statement

Pro forma income statement

estimate the impact of revenue and expense on the profit of the venture

What is the difference between the income statement and the pro forma income statement?

While the income statement is based on measuring financial activities on a monthly or annual basis, the pro forma income statement is a projection or estimate of what the company could potentially do

What else does the income statement reflect?

reflects depreciation and amortization of your company’s assets.

Deprecitation

the cost of wear and tear on your physical assets, such as machinery, equipment, and the building in which you operate.

How does depreciation work?

when you purchase an asset that has a useful life of more than 1 year, you will not include the entire cost of that asset on the income statement in the year that it is purchased. Instead, you are able to spread the cost of that asset over a predetermined period of time; therefore, you record only a portion of the cost each year until the asset is fully depreciated.

Amortization

amortization relates to intangible assets, such as patents, trademarks, copyrights, and business methodologies. Amortization matches the useful life of an intangible asset with the revenue it generates.

Depreciation vs. Amortization

depreciation is for tangible assets while amortization is for intangible assets

Sample Income Statement

revenue

-COGS

= gross profit

-operating expenses

-depreciation

-amortization

= operating profit

-interest expense

-taxes

= net income

Operating Profit

represents the amount left over from revenue once all costs and expenses are subtracted.

What is the interest expense a good indicator of? Why?

a good indicator of the company’s debt, as it represents interest due in the period on any borrowed money.

What is the last expense item before net income?

taxes

What taxes are included?

This line item includes all federal, state, and municipal taxes that are due for the period.

Net Income

Net income is what is left after all costs, expenses, and taxes have been paid; it shows the company’s real bottom line.

Over time, you can begin to compare your company’s income statements; this helps you…

chart trends in your company’s financial performance. The trends will, in turn, help you set financial goals and strategies.

Entrepreneurship can be both productive and unproductive in an economy. true or false?

true

Unproductive entrepreneurs have been referred to as what?

parasites that can damage the economy.

what are productive motives?

those that benefit society

what are unproductive motives?

those that can do more harm than good

Dark Triad of Entrepreneurship

narcissism, psychopathy, and Machiavellianism

Narcissism

Those that are high in narcissism “are superior and too important to be bothered by others’ needs.”

Psychopathy

Psychopathic people demonstrate little, if any, empathy. Interestingly, those high in psychopathy do very well under stressful and uncertain conditions. Yet they have been described as “insensitive to the needs of others and lack remorse.

Machiavellianism

relates to the need for money, power, and competition, and these types are likely to engage in deviant behaviors.

Productive Entrepreneurial Motives

• Generate value for society

• Produce products/services that enrich the lives of people

• Develop a culture in which its employees value their work

• Be admired for the value that it adds to the community

• Attract employees who value the mission of the company as though it were their own

Unproductive Entrepreneurial Motives

• Achieve financial success, even if it is a little destructive to society

• Maximize profits, even at the cost of employees’ well-being

• Grow quickly, even if it means sacrificing quality

• Earn financial profit at all costs

• Outsource work to reduce costs as much as possible

To study dark personality characteristics, what individuals did the research use?

The sample included 508 undergraduate and 234 graduate students at U.S. business schools because the researchers wanted to study individuals who intended to start a business rather than entrepreneurs who had already started a business.

Are narcissism, psychopathy, and Machiavellianism positively associated with a person’s intention to start a business?

the higher the narcissism the more likely the student was intending to start a business. When it came to psychopathy and Machiavellianism, there were no significant conclusions.

How do narcissism, psychopathy, and Machiavellianism relate to motives for starting a business? Are the motives productive or unproductive?

students with strong intentions to start a business had unproductive motives if they scored high on psychopathy and Machiavellianism. Conversely, students with strong intentions to start a business had productive motives if they demonstrated lower levels of psychopathy and Machiavellianism.