Comment by daveungerer | Hacker News Reader

Comment by daveungerer | Hacker News Reader

As someone who's been building financial models for a living up until recently, I have to say that this model isn't very useful as it doesn't answer the most important questions.

The OP focuses entirely on the time period where the revenue line finally catches up with the cost line, i.e. profitability has been reached. But guess what? See all the time periods before that, where the business is running at a loss? Where is the money coming from to fund those losses? That's the up-front investment required - VC, loans or digging into your own pocket.

So that's the first important yet unanswered question: what is the up-front investment before the business can sustain itself?

The second is to calculate the ROI for the above investment, but with a twist: calculate the average ROI at every time period, taking into account all periods before the period being calculated for, but ignoring all future periods. This will provide you with a very important result: you will see that the average ROI remains negative long after your business becomes profitable. You will also see in which time period your ROI reaches an acceptable level - a very important factor when risk is considered.

Yes, it's just a model driven by assumptions. But with the above metrics, you can play with the assumptions (worst, best case etc.) and get meaningful results for decision making.

Disclaimer: The above explanation has been simplified quite a bit. Liberties have been taken with definitions. All your base are belong to us.

I am the author of this blog post - good points on this from a financial perspective. I can tell you were building financial models for a living, because you think ROI is the most important question for entrepreneurs ;-)

For startups, the most important things are good products and good markets. Successful angels and VCs know that, and will invest based on product and growth, NOT financial metrics. Thus, in very few VC pitches will you ever see stats on ROI or payback rate, that's more something you'd seen in the accounting or I-banking world. (I know this from personal experience, having spent the last year at a silicon valley based VC and seeing dozens of pitches)

So if entrepreneurs are primarily focused in the world of products, features, etc., then the key thing is to figure out the metrics that measure how these products tie to external market value. So things like conversion rates in funnels or cost per acquisition become super important, because the features are the steering wheel to your revenue engine. As a result, the spreadsheet model is mostly focused on things that are granular enough to relate to product and functionality, rather than things like valuation multiples or ROI or other overly-broad financial metrics.

If financial metrics are not important for entrepreneurs, and if the most important things are good products and good markets, then why did you write a whole article on creating a PROFITABLE freemium startup? Do you think profit is not a financial metric?

Of course it is, just not as useful in this situation. Hence my suggestion to use metrics that are more meaningful. The metrics that are useful should show you what the risk / reward is for pursuing the business.

It is very important for any entrepreneur to estimate how much investment is required to cover initial operating losses and capital expenditure. It is just as important for them to determine whether this investment is worth the expected future profits.

Just to drive the point home: you can spend 1 billion dollars in year 1 on advertising, if you had the money. And year 2 will be profitable. But you have a terrible business if the profit curve over the next years isn't steep enough to offset the original investment. Simply making profits is not enough.

Maybe you could build a correct model with explanations? That could easily be single most valuable article on HN for the whole year.

That's very tempting. Could be a very good catalyst for an idea I've had:

Been considering creating a web 2.0 type financial modeling site that wizards you through creating various types of models and allows you to collaborate with your colleagues.

Important features off the top of my head: * Export to excel * Ability for others to plug in alternative assumptions to your data (i.e. different scenarios) * Generates a deck of powerpoint slides. * Once the wizard has been completed, models will be edited graphically as far as possible, with the minimum of formulae.

Anyone interested in collaborating?

Anyone know of other websites that make it as easy as possible for a layman to do financial models without resorting to tedious work in Excel?

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