Analyst Interrogative #5
How do we make money?
In our last episode of Analyst Interrogative, we examined the question of how to define key areas of the business and customer base. How should I define that? — maybe the single most important question for most analysts. For more senior analysts, those tasked with setting the companies analytic agenda and prioritization; there is a more important one.
How do we make money? — is the first question I ask when engaging with any new business, unit, or initiative. This question effectively synthesizes the business model and establishes the means in which things must be prioritized, quantified, and (hopefully) communicated.
This Question is Harder Than It Looks
If you know your way around a profit and loss statement, you may be inclined to think this is a straight forward question. At first it may be, but this question reaches beyond revenue minus expense equals profit. Implied in this question is the next step — How do we make more money? As an analyst, it is the only reason you are collecting a paycheck.
Profitability is often not measured in a nominal fashion. While I believe the concept of yield and margin are often taken to extremes, the reality is that the rates and ratios involved in producing profits are critical to decision making and growth. This includes metrics like ROI and Yeild, but also net profit per transaction and net profit per customer or Customer Value. I will not touch CLV or similar metrics in this article… look for something in the future on those.
One thing that may help you solve this question more quickly, most businesses fit a certain model. For instance, some models benefit greatly from efficiency of scale. This can come in the form of fixed cost economics and often mixed models too. Fixed and mixed costs do not increase (or increase more slowly) than growth in volume. So while revenue grows in step with volume, cost are actually falling as a percentage of the growth.
Another possible model that you must recognize is one where revenue (or expense) is leveraged to different aspects of the business. Perhaps costs are based on products in market or customers, but revenue is based on usage or individual transactions. Now the companies profitability is based on adoption and usage, which is growth but a different kind.
The point is that analysts need to understand how the company, product, program makes money. They also need to understand if their business has milestone events which modify that profitability. For instance, network or ecosystem based organizations will often benefit from positive feedback loops driven by growth. Licensing and servicing costs often have rate adjustments associated with scale/graduation points.
Finally, you may even need to learn a little cash flow management from friends in accounting. Finance teams also spend significant time with factors like these, but they often work to reengineer them. These teams are aiming for smoother and more predictable numbers. They are likely amortorizing revenues, deferring costs, and applying interesting labels like contra-revenue and the like.
How do we make money? — is an important question.
Understand your business’ economics, its levers, and the intricasies of its revenues, expenses, and feedback systems will be incredibly valuable to any analyst. Educate yourself on your companies model. Learn from your finance and accounting departments. Investing in your financial education will pay dividends as will tuning in for our next exciting episode of Analyst Interrogative #6 — available here!
Analyst Interrogative is a series created by Corsair’s Institute to increase the reader’s understanding of the analytic process. For more articles like these — please subscribe to Comprehension 360.
