WEBVTT

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And if you don't have high quality data, then you will have poor decisions, and you will not like the life that you end up leading.

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Welcome to the game where we talk about how to get more customers, how to make more

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customers, how to keep them longer, and the many failures and lessons we have learned along the way.

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Hope you enjoy and subscribe.

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If you're an entrepreneur, then you need to be able to make decisions.

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In order to make good decisions, you need to have high quality data.

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And if you don't have high quality data, then you will have poor decisions,

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and you will not like the life that you end up leading.

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And so, one of the important skills or attributes that I believe successful entrepreneurs have

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is in understanding the basic equations of business.

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And so, what I want to share with you today are probably two of the most used equations

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that I use when talking to the portfolio companies that we have,

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when analyzing decisions about what we need to do with the business, where our bottlenecks are,

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et cetera, all right.

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And so, I also think that understanding the equations will make you a better business owner,

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because you'll understand the things that move the levers within how much money you're going to make

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in a business. And so, if you understand that these are the most important levers in the

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business, then you'll be more prudent in terms of when you make decisions around them, all right.

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So, there's the fundamental equation that I like as a simple understanding of business,

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which is just number of new sales or sales velocity, right.

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Number of new sales.

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So, this equation has three variables in it.

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One is the number of new sales per month, which most people know.

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The second is the lifetime gross profit per customer, which most people have no idea.

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And then the third is hypothetical max revenue, which most people also have no idea about.

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And so, then, if this is the equation that I want to get to, right.

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Because from here, I can tell if business is growing or shrinking,

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because let's say your hypothetical max revenue is a million dollars a month,

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and you're doing 1.5 right now.

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Well, it means that at your current sales velocity and current lifetime gross profit,

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you're actually going to be shrinking, right.

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So, like, ah, that's probably a company that I don't want to deal with, or I'm going to know

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that there's a problem, right.

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The flip side is, if I have a company that has a million dollars a month,

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and they're currently doing 500,000 dollars a month,

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then I know that they're going to be growing, and then they will cap a million.

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So, I know that this thing, if we change nothing, will double, right.

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The third scenario, which is actually probably the most common,

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is when people or business owners have, they're at equilibrium.

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So, they're pretty much maintaining the same sales month over month over month,

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and the revenue has remained more or less unchanged.

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That's actually pretty beautiful, because there's other stats you can pull from that

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with very high degrees of certainty, the longer they've been maintaining that period of time,

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and so then you can actually make really good extrapolations about the future, all right.

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And so, that is equation number one, which I would just call like fundamental

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to doing business.

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You have to know how much money you're going to be making,

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and how many of those things you're going to sell, okay.

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Now, the second is, is how do we actually figure out

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what the lifetime risk profit is per customer, all right.

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So, you've got price, times margin,

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divided by turn.

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The alternative to this, this is in recurring-based businesses,

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the alternative to this is simply price margin, price times margin times number of purchases.

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So, it's like if you sell a $100 widget, and the average person buys three of them,

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and you make a 50% margin, then it's 50 plus 50 plus 50, which is 50 times three.

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And so, your lifetime gross profit per customer is 150 bucks.

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The reason that that's so important is that if you know that it costs you $10 for a

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car customer, then you have a 15-to-1 LTVDCAC ratio, which is awesome, right,

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which is high five. Keep going. Keep doing more of that thing.

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But a lot of times, people don't know these numbers are.

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And so, then they can't make decisions.

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They're like, should we increase our marketing expense?

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We do more reach outs. Are these numbers good?

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Right, because people don't understand like, is this good or bad, right?

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Which is kind of funny, because you want to have weight for someone else's judgment on whether

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a number is good or bad. But anyways, we'll get beyond that.

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So, when I know this, when I'm dealing with a company that doesn't know what their numbers are,

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I will walk through these two equations with them.

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So, let's walk through one together.

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All right, I actually had a recent conversation with a company that had a service-based

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business, they were marketing agency of sorts, cool little niche.

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And so, they were selling $1,000 a month service.

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It cost them $100 a month, right, in cost.

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So, there's price. They were selling 120 new units per month.

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They had 40, so these are the numbers that we knew, right, that they knew as of right now.

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And so, from these numbers, we're able to learn a lot about the business, right?

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So, one of these is that they have 90% gross margins, right?

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Based on their new units per month, right?

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We know that we can go 120.

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Why is this not working? Here we go. 120 divided by

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churn, but we don't have the churn percentage.

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Ah, but we do. Because 50 over 380 is your churn percentage, which I'm guessing is going to be like

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13 or something like that. Let's see here. This is 13, 13.1%.

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Right? So, I'm going to buy this by .13, which is going to give me my hypothetical max.

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Ready? This is how business really works. My friends, most people don't want to do this math,

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but this is why most people don't make money. All right, so 923 is the maximum of clients

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that they're going to be able to have at this current juncture.

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So, if nothing changes about the business, their churn stays the same.

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Their number of new customers stays the same. That's where they're going to cap out,

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which means that this business will do $923,000 per month, right? That's where it,

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that's where it'll max out, right? Cool. Nothing wrong with that.

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And they have 90% gross margins, right? Now, there's obviously other costs they have to go

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into doing the business, but they probably run this at, I probably have 40 to 50%

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net margin, because if you're running 90, you can probably cover that, right?

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It's a good business. Six million bucks a year. Good business, right?

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And so, the idea here is, if they're currently, because remember, we know what their

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current is, they're currently at 380,000, because we have 380 active customers per month,

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then this business is going to be a fast growing business, right? I mean, think about,

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they're going to do 120 right now, and their turn is 13%. They're going to be,

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they're going to jump to, you know, 500 next month, and I mean, it's going to, they're going to,

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they're going to jump pretty quickly here, right? But what it'll do because of the

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churn is the churn will start evening out their growth, right? Because this point right here

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is the point of equilibrium. It means that the number of new sales they make compared to the number

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of people that exit the business are the same. So, let me actually spell it out, because I think

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it might be useful. We'll go quiz. You guys already know that I don't run any ads on this,

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and I don't sell anything. And so, the only ask that I can ever have are you guys,

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that you help me spread the word so we can have more entrepreneurs, make more money, feed their

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families, make better products, and have better experiences for their employees and customers.

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The only way we do that is if you can rate and review and share this podcast. So, the single

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thing that I have to do is you can just leave a review, let's take 10 seconds or one type of

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thumb, it means the absolute will to me, and more importantly, it may change the world for someone else.

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So, I said 923 is the max, right, that this thing can do. Why is that? Well, we set the

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turn was 13%, right? So, times 0.13, right, is going to be equivalent to 120. All right? Now,

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if 923 is equal to 120, which is the number of new sales,

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then it means that you're going to have 120 new sales every month, and you're also going to be

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losing 120 every month, which means zero growth. All right? That is a point of equilibrium.

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The reason the equilibrium point is so important is that that's where we know we can, like,

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that's where we're going to level out again, we have to find a new channel for growth, right?

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Now, right now, if your business is plateauing, then you can make, you can make these assumptions,

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and you can do this math about your business. A lot of people are like, I don't know what my

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LTV is, right? And I'll give you a simple another example of something like that of a business

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in equilibrium. So, let's say you've got a business that's doing $100,000 a month, all right?

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$100,000 a month, let's say, you know, the price point is, you know, I'll use simple numbers here

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again. So, let's say it's $1,000 a month, right, for the services. All right, which means that

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they have 100 customers. Simple business so far, right? So, now, the question is just going to be

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sales velocity in turn. So, let's say that they've got 10% turn, and they've get, and they get 10

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new customers per month, right? And the thing is, a lot of people don't know this number, right? Which

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is silly to me, but a lot of people don't know the number. But the thing is, if you are in equilibrium,

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and they're getting 10 new customers a month, then I can tell you the turns 10%, right? I don't need

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to, I don't need them to calculate it for me. I know, like, so you haven't grown for six months,

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yes. Let's average out the number of sales that you get month over month over the last six

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months, and then they'll tell me it's been, you know, around 10. I'm like, okay, well, if you have

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100 current, right? And your outflow is 10, and you haven't grown, sorry, so your inflow is 10,

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and you haven't grown, then it means your outflow is 10. And then it's simply 10 over 100,

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it's 10%. That's the game, right? And so now, you're like, well, why do I want to do all that stuff?

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Well, now we know what the LTV is, because again, they're probably not going to know what that

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number is. So we say, okay, well, $1,000, remember, do, do, do, do, times our margin percentage, right?

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I didn't put the margin in here. Let's just say it's 80%, right? Times 80%. And we divide it by

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sure, which is 10%, right? Which means that we're going to make $8,000 per customer, all right,

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in gross profit. The reason this is important is they might be like, I don't know how to grow. I'm

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like, we're making eight grand per customer. How much is it costing you to acquire a customer? And

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this is, this is where it gets funky. A lot of people are like, well, it costs about a thousand

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bucks to acquire a customer. And I'm like, great. Why don't we do 10 times more of that? And sometimes

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it's really that simple. It's like, I just, we never saw like that. I'm like, right, you're spending

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1,000 to make eight. Let's play that game as many times as we possibly possibly can. Right? And

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if it's like, well, we can't do, we've maxed out this channel. It's like, okay, well, we have $8,000

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to work with in order to acquire customers, right? But let's be real for a second. You don't want

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to run a nonprofit, even though a lot of people do. But if you're in the game to make money, right?

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Then this $8,000, right? Realistically, in order to have a sustainable business, you need to have

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a three to one or higher, right? It's called the LTV to CAC ratio, all right? And so for me, I

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personally really don't look at businesses that have less than this. 10 to one. And that's just

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the choice. You can do that. But there's tons of research studies that have figured this out,

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especially in the software world. A lot of things are quantified or quantitized or whatever you want

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to say here, right? Is that three to one LTV to CAC ratio or greater is what is necessary for growth.

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All right. And a lot of this also has to do with cash flow. So imagine for a second,

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that you had a $10 per month thing, right? Okay. And let's say you had someone and you know,

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they're going to stay for 10 years, something super long, right? 10 years. That's a very long LTV.

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But the total lifetime value of a customer like this for 10 years is 120 months is going to be

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1200 bucks, right? And let's just assume it's a digital product so that there's almost virtually

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all gross marks, right? Well, the thing is is you might have a three to one. So let's say it costs

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somebody, you know, let's say it costs you 200 bucks, right? To acquire this. You're like,

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whoa, I'm going to be rich, right? But the thing is is $200 is 18 months or 20 months,

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rather excuse me, is 20 months. It's going to take you 20 months to recoup off of your $10 per month,

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right? And so your cash flow is going to be horrible, right? Even though the business fundamentally is

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good. And that's why people raise capital and they take outside investors and all kind of stuff,

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right? But the game is then figuring out, which this is actually the topic of my third book that

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will come out probably in a year or so. It's called Money Models, which is how can we figure out a

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way to make money getting this customer? How can we figure out a way that we can we can do a little

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bit of, you know, money kung fu and figure out a way to either decrease the cost of acquisition,

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right? If we can get this from 200 to let's say 50, right? It's like, okay, well, now I got five

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months. It's like, okay, can we can we put some sort of like, you know, buy, buy three months up

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front, you know, or buy, buy five months up front by your first, your first year is half off,

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right? If we know they're going to stick. So if we did first year at 50% off, right? Then we're

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going to have $60, right? That we're going to make upfront, right? And we know that it's going to

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cost us $50 to make this $60. So we actually have plus 10 in cash flow for the business within

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on the first transaction. And then we can keep spending our money around. And we just know that 12

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months from now, this guy's going to start recurring at $10 per month, right? And then we're good to

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go. But this way we cash for the acquisition. And so that's the kind of little stuff that I think

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it's just sometimes they see experience having done this a lot of times to know. But anyhow,

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this is definitely a more in the in the in the trenches. How do how we look at businesses that

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were looking to acquire percentages of it in the portfolio? These are the two fundamental

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equations you have to know, like the back of your hand did to do, right? You have to know this one

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and you have to know how to calculate LTV. If you have those two equations, you can pretty much

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learn everything you need to know about a business on the back of a napkin. All right, so

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hope you found this valuable. If you did, my name is Alex Ramosey. We own acquisition.com to

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portfolio companies that's about $85 million a year. Keep being awesome, Mosey Nation. A lot of

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people are broke. I don't want you to be one of them. That's why I made this channel. Click subscribe

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if you dig it. Don't click if you don't. Either way, I love you. Catch you guys in the next video. Bye.