Tuesday, November 17th 2020 (6 months ago)
As founders, almost every action we execute supports maximizing revenue, whether directly through sales or indirectly through our mission and values.
The revenue formula is the mathematical representation of how a company generates revenue. To determine our output, we will boil down the equation into controllable inputs. By controlling these inputs, we can identify and eliminate our inefficiencies.
The revenue formula works because it forces startups to track and define metrics. At Forecastr, we believe that measuring actual outputs against key performance indicators sets up our startup for long-term success. The revenue formula essentially forces us to define and calculate multiple key inputs, which become critical to long-term visibility and growth.
To help illustrate the revenue formula in action, we will use a monthly subscription-based business as our subject. Subscription based services indicate the customer pays a stable monthly price for a continuous service or product, like Netflix, Hello Fresh, or Bark Box.
Revenue equals price multiplied by the number of monthly subscriptions:
Revenue = Price * Subscriptions
Simple enough, but we need to dig deeper. Our goal is to boil the business down to base level, controllable inputs. At the end of the day, we want to maximize revenue.
Within the equation, we identify two categories: retained subscriptions and new subscriptions.
From new subscribers, we can break it down even further.
From retained subscriptions, we identify two categories:
To calculate the churned subscriptions, we need the churn rate multiplied by previous month’s subscriptions.
Check out the diagram below to see the entire breakdown for a subscription based revenue formula. Keep in mind, inputs change as your business evolves. Breakdown each category down allows us to isolate performance within each category to identify inefficiencies.
Diagram 1: Revenue Formula for a Subscription-Based Startup
If we begin to see an overall decline in revenue, this equation allows us to isolate the root cause. For example, if our price per subscription is competitive, but our retained subscriptions decreased, we can come up with a plan to reduce our churn rate. Not only can we use this data to motivate our teams, but we can quickly change our marketing strategy to optimize sales.
Even more, understanding this data allows us to communicate with our shareholders more effectively. This visibility proves our ability to manage and build efficient revenue streams. The more our business grows, the more revenue streams we utilize. Without this visibility, we may invest marketing dollars on inefficient inputs. Additionally, from an auditing standpoint, we can prove our ability to document and control the variables of our businesses.
Examine the high-level structure of your business. Lay out the equation and methodically drill down each data point until you identify the variables. Controllable inputs constitute your revenue formula, which ultimately lays the groundwork for strategic business growth.