Master the Fundamentals

Business has just two fundamental parts: Investments and Deliverables.

Investments: the money used to create the products, services, and experiences.

Deliverables: the actual product, service, or experience purchased by the customer.

This cycle continues throughout the life of every business, and the ones that scale are able to profitably sell deliverables and reinvest back into the business at higher and higher capital levels. This applies to every business in every industry.

To illustrate this, imagine you sell (fill in the blank) and it costs you $10 to make. If you sell it for $40, your gross profit margin is 75%, a great number by investment standards. However, if you don’t sell enough to pay for the other business expenses (e.g. sales, marketing, administration, R&D, etc.) then, you don’t have any money to reinvest, which means that it has to come from debt or equity raising. This is how so many “unicorn” startups are able to continue to grow even though they are losing tens of millions of dollars. It’s also why so many go public before they’re profitable – not only as an exit strategy, but as another way to keep growing unprofitably.

For most businesses, this is not possible. In most cases, profit matters a lot. It’s the only way to scale; get money, invest to get more money.

Let’s look at another illustration using the information above. Using the $30 gross profit, say you sell 100,000 units of (fill in the blank). That’s $4 million minus $1,000,000 to produce and if it only cost you $2,000,000 in total business expenses, you now have $1,000,000 before taxes (i.e. operating income) to put on top of the money you’re spending currently.

I don’t want to get too deep into the accounting of business, but since most of business works on contracts spaced out over 15, 30, and up periods, a business can front load “accounts receivable” and either borrow on a revolving line of credit the money needed to fulfill the orders, or use their own contract terms with suppliers.

Today, since so many companies are trying to compete for customers, the one’s that have sales usually get their orders filled without too much added interest. Obviously, if you run a retail business, the inventory turnover is where the bread is made. That’s why many are big companies closing stores because they may be producing decent gross margins, but after the other business related expenses, the cash flow dries up and the company isn’t able to grow any more.

For a college and graduate level explanation of business, read Warren Buffett’s letter’s to shareholders – starting in 1977. (direct link below)

http://www.berkshirehathaway.com/letters/letters.html

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