Startups without a strong understanding of their financial models can be like a Joker — simply burning investors cash.

Margins Call: Why Startups Need A Stronger Understanding Of Their Financial Models

In the last half a year while I was helping startups, I had a privilege to build a few financials models and P&L for these new businesses. While doing so I have realized that founders have a profoundly wrong idea of what their business is.

That is, until they see the numbers and how the outputs change when the inputs change.

In doing so, I became profoundly fascinated by the margins. So out of curiosity, and because I’m in Japan and love candy, I started a new company, SUGADADDY シュガーダディ, that supplies a box of obscure and unique Japanese candy anywhere in the world for one low flat fee.

I knew I didn’t want to spend weeks researching the market. I had to quickly test my hypothesis whether or not it’s a viable business. So I asked my friends who wanted candy to order it, promising them to ship them candy at cost. I got a bunch of orders, and in just one weekend had learned more than some learn in months — I simply ran a tally of all my receipts, put them all in a spreadsheet, and by Monday knew what my true costs are.

I got all my marketing research done for free — in fact, it was paid for by my friends, who were happy to get the sweets at cost.

Because there are so few moving parts in this simple business, I also knew straight away where I can lower my costs — buying tax free to save about 5% per order, and when more orders come in, focus on operational efficiencies by buying own boxes, buying wholesale (currently buying at retail with about 40% markup to wholesale), and shipping bulk to a country with most orders and distribute locally.

All this information goes straight into a spreadsheet to test my assumptions and learn about the business without actually investing into it.

After the weekend, I was able to observe competition from a whole different point — I knew when they were “cheating” (i.e. putting cheap heavy items in their boxes), or trying to save up by bundling (i.e. offering boxes that ship once a month, instead of on-demand).

Startups, especially the one’s selling physical goods or providing physical services, live and die by margins.

Knowing how to run and build a business model that makes financial sense takes a clear head, and a business mindset, which is the skill a surprising amount of founders are lacking.

Evgeny Tchebotarev is a founder of 11-million-photographers-strong community 500px, backed by Andreessen Horowitz; and currently helps other companies unlock 10x potential. He is usually based in Taipei, Taiwan.

If you want to help other people discover good stories like this, please clap when you are done reading 👏