Follow The Cash

Chapter Five, “Follow the Cash,” delves into the critical aspect of managing unit economics in a business. We emphasize understanding the true costs and revenue per unit sold, acknowledging that many new business owners overlook or underestimate various costs.

Key insights from the chapter include:

1. Understanding Unit Economics: The chapter begins by stressing the importance of fully grasping unit economics – the calculation of revenues and costs on a per-unit basis. This understanding is essential for controlling and guiding the growth of your business.

2. Profit and Loss (P&L) Analysis: The authors highlight the necessity of a comprehensive P&L analysis, especially focusing on the often overlooked or underestimated ‘loss’ side, which includes all the costs associated with producing and delivering a product or service.

3. Contribution Margin: The concept of ‘contribution margin’ is explained as the per-unit difference between sales revenue and associated costs. A key issue for many businesses is not accounting for all variable costs, which can lead to inaccuracies in assessing profitability.

4. Hidden Costs: The chapter warns about various ‘invisible leaks’ or hidden costs that can unexpectedly impact the bottom line. Examples include changes in software subscription rates, tax and tariff policies, and specific challenges related to shipping and handling.

5. The Impact of Growth on Costs: As businesses grow, so do their costs. The authors caution against underestimating growth-related expenses like increased software fees, larger warehouse needs, and higher customer acquisition costs.

6. Returns and Refunds: Understanding and managing the costs associated with returns, refunds, and discounts is crucial. The authors suggest creative strategies to minimize these expenses, such as offering alternatives to refunds.

7. Seasonality and Market Trends: The chapter emphasizes the importance of recognizing and planning for seasonality and market trends that can affect sales and costs.

8. Creating Accurate Benchmarks: The solution to managing unit economics lies in creating internal and external benchmarks. Internally, this means making educated guesses about costs and revenues, while externally, it involves understanding industry norms and competitors’ practices.

9. Continual Review and Adjustment: The authors advise continually reviewing and adjusting these benchmarks to stay aligned with reality, emphasizing that perfect predictions are impossible, but closer approximations can be achieved.

10. Exercises for Understanding Unit Economics: The chapter includes exercises to help business owners develop a deeper understanding of their unit economics and to compare them with industry standards.

In summary, Chapter Five focuses on the critical importance of understanding and managing unit economics in business. It underscores the need for meticulous tracking of costs, regular reviewing of financial assumptions, and strategic planning to avoid cash flow issues. The authors highlight that successful founders manage their unit economics deeply and strategically to ensure business sustainability and growth.