Lesson 15: Financial Models Predict the Future

(0:00 - 0:09)

And let's get into it. Another one. Today we're talking about how financial models can predict the future.

(0:09 - 0:50)

Alright, so first off, we're going to define what a financial model is. A financial model, in its most simple form, is taking the revenue, projecting that into the future, your cost of goods sold, what it costs you to deliver that product or service, to earn that revenue over time, and then the operating expenses, which are things like research and development, sales and marketing, and then your general or admin expenses. Now, if you've been watching our videos since the beginning, then you're in the mindset of the fact that product does drive growth.

(0:50 - 1:42)

So if you focus most of your expense on product, the raw materials, the capabilities, that means your R&D expense is going to be large. Now, if you do it correctly, and you infuse strong core values, and you create something completely unique and novel that connects with the market, and there's built-in desire and demand for it, that means your cost structure for sales and marketing is going to be a lot less. You're going to have to pay fewer influencers, you're going to have to pay for fewer ads, there's going to be people who reach out and contact you, who want to partner with you, customers who are geeked on your brand, geeked on your product, and it just feels better and it's more natural, instead of, once again, shoving your stuff down people's throats when they don't want it.

(1:42 - 2:06)

For example, if I'm a used car salesman and I knock on your door every single day, no shade to the used car salesman, we need to sell some used cars sometimes. But if I come to your front door and I knock on your door every day, and I'm like, hey, you want to buy this car? You want to buy this car? You want to buy this car? You want to buy this car? No one is ever going to buy that car from you. And in fact, they may call the police and tell you to stop.

(2:07 - 2:18)

So that method just doesn't work. These hacky sales things, it just doesn't work. The better method is like the case study of the iPhone.

(2:19 - 2:37)

The iPhone, the most successful product in human history, arguably. They launched, and every single year, they did more revenue, they sold more product than the prior years combined. They did that for year after year after year after year.

(2:37 - 2:58)

They just kept pushing more product into the market because the demand was so overwhelming. Why? Because they put something out there that never existed before. Sure, it was a systems integration project where they brought together the internet, a music player, a touchscreen device, Bluetooth, accelerometer, GPS.

(2:59 - 3:15)

They put it all in one device so you didn't have to carry a camera, a phone, an iPod. And so it just became obvious like it's simpler, it's more personal. Everything on that device is 100% for me.

(3:16 - 3:28)

My emails, my text messages, my content, my video, everything was for me. My apps, it was all for me. And I even got to pick the color as long as you, you know, you can have any color as long as it's black.

(3:29 - 3:42)

Shout out Ford Model T back in the day. Okay, so then back to the financial stuff. How does that predict the future? Well, if you've done all these things correctly, then what you can do is you can create a spreadsheet.

(3:42 - 3:59)

And you can have an assumptions piece in there, which is like, okay, we could do these basic assumptions, which is like, hey, revenue is going to grow 5% per year forever. And my cost structure is going to grow 2% per year. So then that gap of profitability increases.

(3:59 - 4:20)

And then here's the question, right? You can put any number you want to in a spreadsheet, so it's fake. So how do you get a spreadsheet to model reality such that your prediction accuracy is really high in the future? Prediction, when you hear prediction, think artificial intelligence, because that's what it is. It's a predictive model.

(4:21 - 4:38)

Okay, so how do you do these things? Well, a lot of folks at first will do top-down instead of bottom-up. What do I mean by this? Top-down. Top-down is essentially like, I'm going to do 1% market share with my product.

(4:38 - 4:47)

So you take the whole market, a billion dollars, you multiply it times 1%. And that's our revenue for the year. That's pretty unsophisticated.

(4:47 - 4:57)

The more sophisticated is you say, here's my first customer. Here's how much they're willing to pay. Here's how much they pay me every month.

(4:57 - 5:11)

And then here's how many customers I can realistically onboard into my product or service every month. And you multiply those out, and that's your revenue in every month. Then you take a look at the cost.

(5:11 - 5:28)

So like, okay, if I sell one in the first month, what are my component costs in order to deliver that? If it's software, you've got, like, hosting costs. You've got maybe some people costs. Maybe you have, like, you set up a website or, like, a Shopify or something.

(5:28 - 5:55)

That's a cost at $10, $50, $100 a month. So you add all those things up. And then, basically, the real question is, how are you going to get that one customer? What needs to happen? And so that customer, through the essence of product management, talking to your customers, understanding the market, they will tell you, like, well, actually, I wouldn't buy it, and I'd only buy it if these things exist.

(5:56 - 6:09)

So then you go build those things, and then you go back to them and say, hey, I have these things. Now what? And they're like, eh, yeah, but I'm kind of happy with what I have right now. And they're like, but actually, if it could do this thing and that thing, then we might have something.

(6:09 - 6:19)

So then you go back, and you build that thing and this thing, and then you go back to them again. And they're like, all right, I'll give it a shot, but I'm only going to give it a shot for, like, one month. So then you get that one-month payment.

(6:19 - 6:25)

You deliver it to them. You check in with them partway or at the end of the month. And they go, actually, it was pretty good.

(6:25 - 6:30)

I think I'll sign up for another one. And then they do another one. Then you go back, and you do the same thing for the next one.

(6:31 - 6:46)

And if you're thinking to yourself, man, this is a lot of work. Yes, that is the way it's been done for thousands of years. And we think magically on the Internet, we just, like, post a tweet or an image on Insta.

(6:46 - 6:52)

Magically, we're going to become billionaires. It just doesn't work that way. There's too much noise in the market.

(6:52 - 7:06)

There's too many lookalike products. So you've got to go to outer space and bring something from the future that may look alien at first and bring it back down to Earth. The iPhone looked alien at first.

(7:06 - 7:27)

What do you mean I don't have buttons on a phone? What do you mean I can't? Like, I can see the Internet, but it only goes tick, tick, tick. What do you mean? Wait, what do you mean I have my iPod? Oh, snap. Wait, you've got Maps? Wow, so, like, I can just open up my phone, and it will tell me how to get from A to B while I'm driving or walking? Wow, that's pretty legit.

(7:28 - 7:33)

Okay. Wait, so I can get, like, my text messages, and then, oh, snap. Okay.

(7:33 - 7:40)

Wait, so now there's, like, new applications I never had before, like Uber and Instagram? Oh, wow. Okay. Neat.

(7:41 - 8:00)

So I'm willing to sign up for a new iPhone next year, and then maybe I'll pay for some extra storage space, either per month or, you know, I've got to upgrade my storage space because I was taking all these pictures now because I've got a video camera and a camera on my hand. Alien technology. The future was brought today.

(8:00 - 8:09)

So where's today? Today's emerging tech. AI, Bitcoin, spatial computing, blockchain, yada, yada, self-driving. Bring that stuff.

(8:09 - 8:25)

Systems integration project. Bring all those emerging technologies together and deliver a new capability to your customer base, and then brand it and add strong core values. Then when you go into your spreadsheet, now you can accurately model out the future.

(8:25 - 8:39)

And these many customers through this method, and I do this many ads, and I get this many people, and that costs me this much. And then I start to model that out. And then I hit enter, and then I can see over time, well, okay, cool.

(8:39 - 9:01)

Like, I'm going to make a million bucks the first year, five million bucks the next year, and then like 20 million, which is kind of wild because I distribute it via the same mechanisms in these new markets. And I have these new distribution channels set up. And then you take that to a capital provider if you need more capital and you can't bootstrap it yourself.

(9:01 - 9:10)

And they're like, okay, you proved period one through seven. All right, I'm willing to bet that you can do eight through 12 now. So here's a little bit of money.

(9:10 - 9:26)

Go test it out, and then come back to me in a couple months. And like, did you hit those numbers? Oh, you exceeded those numbers? How'd you do that? Oh, you got this new idea, and you onboarded this new feature. And then the market really liked it, and they started talking about it to other people.

(9:26 - 9:35)

Magic. That's desire, right? And then your cost structure went down. Wait, so your profitability went up and your growth rate went up? Whoa, dope.

(9:35 - 9:42)

Here's some more money. Actually, let me go tell my friends who are looking for a good place to invest in capital. Hey, George.

(9:42 - 9:44)

Hey, Lucy. Come here. Like, check this thing out.

(9:44 - 9:50)

You got to talk to these guys. All right. And yada, yada, yada, and on it goes forever.

(9:50 - 9:57)

And then they tell people, and they start repping the brand. And so it just becomes like a self-fulfilling prophecy. So there we go.

(9:58 - 10:23)

That's it. That's how you predict the future using all of the stuff we've talked about before in a spreadsheet. And then that becomes an artifact in your data room that capital providers can do diligence on, and then trust and believe, talk about it amongst their team, their investment committee, make a decision, do an acquisition, do an investment, give you some loan, some debt.

(10:24 - 11:03)

And then you just go and you keep doing it, and you just keep doing it better. So you just got to be really careful that you don't lie in those things, because if you are delivering something to the market and you're untrustworthy about it, then not only damages your reputation, but if you're selling a security, which selling shares in a company is selling a security, you actually have a legal and fiduciary risk with the United States SEC if you're in the U.S. Other territories and domiciles have different laws, rules, and regulations, but a fundamental principle is like if you're lying about your financials, you're done. You're so done.

(11:04 - 11:10)

So, yeah, don't do that. Get as clear as you can. And in order to—it's a forcing function.

(11:10 - 11:27)

That spreadsheet is a forcing function that forces you to go to the market and prove what's in that spreadsheet. And you will adjust your assumptions as you learn more. And I can almost guarantee you that you're going to overestimate what you can do in the short term.

(11:27 - 11:45)

And if it really works and it is as truly novel and game-changing, then you're going to underestimate in future years. Years 5 through 10, you're going to completely underestimate. Years 0 through 1, you're probably overestimating your ability to, like, push this thing into market and get critical mass.

(11:45 - 11:59)

Chat GPT, iPhone notwithstanding. So those are two incredible case studies for how to build something, create something truly unique and novel that solves a real problem. You put it in customers' hands.

(11:59 - 12:02)

They talk about it. They can't get enough of it. The press goes wild.

(12:03 - 12:08)

Crowd goes wild. And you go home and you kiss babies and whatever. All right.

(12:08 - 12:13)

That's it. It's a magical, beautiful day out here. Check it out.

(12:13 - 12:16)

Super cool. Anyways, we're out of here. Bam.