Simple Financial Distillation as a Mental Model

This post is by David Cummings from David Cummings on Startups

Yesterday, I met with an entrepreneur, and we discussed a variety of ideas related to building community. Late in the conversation, he shared one of his favorite mental models and asked for one I liked. After thinking for a second, I knew my go-to: simply distilling the financial model or business down to its most basic format. The idea behind this exercise is that if the financial model doesn’t work at the most basic level, it’s unlikely to work at a more complex level. Conversely, if you can’t break it down into a simple form, understanding it at a complex level becomes challenging. If it’s so complicated that you can’t understand it or help others understand it, the chance of success significantly decreases. Let’s look at a couple of examples. In the first example, with software as a service, it’s easy to describe what the product does, whom it serves, and how it will work in the real world. Even with all that, if it’s not clear that our business model is to sign up 1,000 customers, who will pay us $10,000/year, and we plan to sign up this many more customers over the years, and we believe that with the gross margins and everything else, it will be a viable, if not great, business, then all the other pieces don’t matter. Of course, businesses are much more complex than that, but at a simple level, what is the financial model? Look at a second example. If you talk about (Read more…)