Often, entrepreneurs get too caught up with managing operations, or are too enamored by their soon-to-be launched product, that they sometimes forget to think about the basic economics of their business. Here are the two useful frameworks for business owners which are, in fact, very basic material and almost ‘doh-worthy, but I thought it was worth putting it out there anyway:
Used for analysing changes in profitability
A simple income statement is a very useful framework. By analysing profitability through its component factors such as revenues, COGS, operating expenses, you can quickly direct your analysis. For example, if profits are declining because of a fall in revenues, focus on marketing issues. If profits are declining because of rising expenses, you may want to look into operations and financing issues.
Three ways a company can increase profits:
Increase Unit Price
- Demand elasticity
- Market power
- Product differentiation
- Is a premium justified
Increase sale volume
- Increase sales to current customers with current products
- Increase sales to current customers with new products
- Increase sales to new customers with current products
- Increase sale to new customers with new products
Decrease costs
- What costs are fixed and what costs are variable?
- To what extent and in what time frame are costs avoidable
- How are costs allocated
Make sure you understand the cost structure of a company in analysing its profitability. Capital-intensive industries such as manufacturers typically have high fixed costs which makes capacity utilisation a crucial part of their business. However, don’t think that tech entrepreneurs aren’t privy to this problem.
Are you an inventory-led e-commerce business? The inventory led e-commerce models have almost the same economic characteristics as the traditional brick-and-mortar model when it comes to inventory risk exposure, warehousing, and sourcing. When fixed costs are high, there are often opportunities for economies of scale or scope. Use your common sense to understand what the important input factors are for a company. Carefully analyse the allocation of overhead expenses.
Very basic, but when you keep revisiting the list while thinking about the economics of your business, you will often find that there are aspects which you have not thought about yet.
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