Lean Financial Model

Supporting document

Welcome to your guide to completing the Lean Financial Model (LFM).

The LFM is a tool for start-ups to clarify their business models and review the financials. It applies to both new companies with investors and innovation teams within large corporations.

It is advised to print the model on A3 paper and complete it by hand. This gives a back-of-the-en-velope feel and stops the calculations becoming a burden! The LFM should take no more than a few hours to fill in and is ideally worked through in a small team.

With three clear sections, the model is easy to complete. This guide will walk you through each part using an example: a start-up shoe shop.

Lean Financial Model

Supporting document

What describes your business?The first section of the LFM is designed to define your business model and starts by asking what type of business is being developed. We’ve identified four categories which we believe (almost) every business can fit into, either directly or as a combination of multiple types.

All that is required is to tick the relevant box(es) by thinking about what you are offering customers.

• Manufacturing a product; “actually building something” Examples: printing shop, bakery

• Buying & reselling; “the typical retailer” Examples: clothes shop, book shop

• Providing a service; “offering desirable assistance” Examples: home removals, boiler care

• Running a platform; “bringing parties together” Examples: Facebook, Uber

For a shoe shop, the business is based on buying and reselling shoes, so this box has been ticked.

Business model

Lean Financial Model

Draw your business modelTh e next section gives you space to draw your business model. As a starting point, we’ve created examples for each of the four categories above. Th e aim is to outline all the key stakeholders and use arrows to represent the relationships between them. Try to be as specifi c as possible and the result should be a clear visual of the structure of your business.

Business model

Manufacturer

Sandwich shop

Dealer

Supermarket Customer

Customer

Supplier

FarmBakery

Manufacturing a producte.g. Sandwich shop

Dealer

Car dealershipCustomer

Manufacturer

VolkswagenSkoda

Buying and resellinge.g. Car shop

Key: = multiple = product / service fl ow = money fl ow

Service Provider

Taxi driverCustomerCar

Taxi company

Licence

Providing a servicee.g. Taxi driver

Platform

Airbnb

Customer

Running a platforme.g. Airbnb

Homeowners

Lean Financial Model

We suggest using various arrow heads to characterize the different relationships; for example, product flow, service, communication, money etc. Consider using pictures instead of words to represent different stakeholders, such as a stick man to represent your customers or draw the logo of a partner company. Anything to make the visual more understandable is advised!

The basic business model for a shoe shop involves buying the shoes from manufacturers, then reselling them to customers.

Business model

Lean Financial Model

What is the growth model?In his book, “The Lean Startup”, Eric Ries defined three growth models that can be used to describe all start-ups. Decide which one(s) best fit for you – if multiple apply mark the order of priority, bearing in mind start-ups are advised to only focus on one growth model at a time.

• Paid: the lifetime value of a customer > customer acquisition cost The profit generated from each customer is reinvested into more advertising to further accelerate growth. Examples: travel agents, telecommunications company

• Viral: customers acquire/activate other customers as a mere and necessary consequence of normal product use Your customers do the advertising for you: every customer brings at least one customer to your business, sparking rapid growth. A difficult strategy to rely on though! Examples: Twitter, Skype

• Sticky: very high customer retention rate as customers become hooked for long periods of time The focus here is on low customer attrition: prioritising existing customers before finding new ones. The aim is to keep your customers returning week after week. Examples: supermarkets, cafes

In the shoe shop example, the main growth model is ‘paid’ as money will be spent to market the shop and acquire new customers. ‘Sticky’ is also important and this could become a focus at a later stage, ensuring the customers who buy shoes return to buy more.

Business model

Lean Financial Model

Who are the customers?This question really asks, “Who do I get money from?” It is important to focus on who is actually pay-ing you as this can also identify stakeholders who aren’t yet generating revenue, but could do so in the future.

The customers for a shoe shop are simple (visitors who buy shoes), but there are cases where the paying customers are not the common user of the company (for example, Facebook).

Why are they paying you?Consider what your unfair advantage is: why are customers paying you and not a competitor? What is not easily copied or bought? This could include insider knowledge, personal authority or the name of your organization.

Ideal location and prices others are unable to compete with are good examples of an unfair advantage for a shoe shop.

How is my business creating value for them?There is a direct link between this question and the ‘value proposition’ aspect of the Business Model Canvas. What’s your unique selling point? Why do you stand out? Work out what makes you different and link that to the customer problem you’re solving. Also consider the benefits the customer gains after interacting with your business.

A shoe shop may be different if it sells a type of shoes no other competitors do; making the shop worth visiting and afterwards the customer owns a pair of Italian shoes.

Business model

Lean Financial Model

Map your business driversThe next part of the LFM dives deep into the factors that influence the success of a start-up. Beginning with EBIT (earnings before interest and taxes), the tool splits into costs (outgoing money) and revenue (all income). From here, brainstorm all drivers that impact costs and revenue, as well as everything these drivers are dependent on - it may be useful to begin by looking back at your Business Model Canvas. Include as many drivers as your can, as well as any external influences, such as; regulation, policy, com-petition, licenses, law, insurance, weather etc.

Revenue can be related to many aspects, such as the number of sales, margin per customer, number of partners etc. Costs will often break down to CTS (costs to serve) and CTA (costs to acquire), though there could be more! Consider all your expenditure relating to these, then what they are reliant on. Don’t forget to include costs for: IT, logistics, resources, marketing, overhead etc.

You can see from the example the drivers that impact the success of a shoe shop.

Drivers map

Lean Financial Model

What are the main drivers?Having mapped all the drivers, it is now time to consider which ones have the biggest impact – looking at the drivers map, which three really drive the success of your business? It is important to reflect on these and test how to make them have the most influence – hence the “Tested?” tick box. If you haven’t already done so, we suggest bringing the testing of the main drivers into your short-term plan. How can you be confident your company will boom if you haven’t refined the factors that will have the biggest impact on success?

For a shoe shop, the three main drivers are taken directly from the drivers map. The business will earn the most money if there is high footfall in the shop, the greatest number of shoes purchased and maxi-mum margin gained from each sale. The second driver is ticked because hypothetically this start-up has tested ways to increase the number of visitors to the shop; for example, rearranging the store layout, a marketing campaign, placing a sign outside the door etc.

Drivers map

Lean Financial Model

KPIThe third section of the LFM places more focus on the actual financial figures. The first part of the table asks you to set KPIs (key performance indicators) for the next three years (quarters for the first year; halves for year two; year end totals for year three). These are performance metrics – measures to evaluate the success of activities or behaviours – and are likely to be linked to your main drivers. How will you measure your main drivers over time? Also think about which drivers are priorities at different times and put them in order of priority (first, second or third) for the relevant period.

Ideally a start-up should focus on one KPI at a time, meeting the desired target before moving on to the next. The dotted line between each period represents the flexibility in timing as there is little point focussing on the next metric before the current one is achieved.

The main KPIs for a shoe shop are metrics related to the three main drivers. In quarter one, the busi-ness is still in the set-up phase, but by quarter two the number of visitors to the new shop is now vital. Monitoring this and testing ways to increase footfall is crucial for the first six months, or until a target number of visitors per day is constantly achieved. After this, converting these visitors to customers (i.e. they are purchasing shoes) should be the next focus and therefore tracking the number of sales is es-sential. Once desired sale figures are achieved, then the start-up can focus on making more margin per customer and ultimately maximum profit for the business.

Figures table

Lean Financial Model

CustomersAfter the KPIs have been defined, the LFM guides you through simple calculations to give an estimated profit at the end of a three year period. The idea is NOT to spend hours researching exact numbers! The aim is to get a feeling for the figures – use your knowledge and instinct to input sensible answers. This is an easy, quick way to assess if your business is on a path to making money.

The customers section of the table has two key aspects: the number of new customers and the number of leaving customers. The total line represents the number of active customers at the end of the period – be sure to include the figures from the previous period if they continue to be existing customers.

In the case of a shoe shop, a customer is defined as someone who purchases a pair of shoes (not just visits the shop). The figures shown are based on the number of sales per hour for an eight hour day over a six day week.

Figures table

Lean Financial Model

CostsIt is of course important to review where the business will spend money in the foreseeable future. Please adjust the figures to your local currency! A good starting point for both the costs and revenue sections is your drivers map and the factors identified there.

The € per product line highlights the money spent on purchasing/manufacturing the product the busi-ness will be selling. It is related to companies who are selling a product, rather than providing a service or running a platform – refer back to section one of the LFM. If your business model is based purely on service, put a dash in this section as your costs will come into the CTS lines.

The following four lines look at the CTS and CTA per period and per customer. Under CTS, consider any specific costs related to serving the customer. This will be higher for a service based business and includes, for example, running costs, employees etc. Marketing and advertising are two umbrellas that fall under CTA, as well as any other costs associated with gaining customers.

Overhead costs refer to the costs associated with the company building (such as rent and bills), as well as specific support functions within your business; for example, HR, finance, legal etc.

The Other line is available for all expenditure unaccounted for so far. Examples would include one off costs, like start-up costs such as kitting out your office. This line can also be used for miscellaneous and unforeseen costs, should you wish to include a buffer.

The final line in this section is a total of all costs. This is calculated by adding the previous four lines (‘CTS per period’ down to ‘Other’).

Looking at the example of a shoe shop, the € per product is the average cost of purchasing a pair of shoes from a manufacturer. This decreases over time as the number of shoes being bought increases (reduction from buying in bulk) and also due to factors such as a stronger relationship with the manu-facturer. The CTS figures are based on employing a shop floor salesman and general running costs and the CTA numbers are based on marketing campaigns and running a website. The Overhead costs come from rent and bills and also a deposit in quarter one of the first year. In this example we have included a buffer for each period in the Other line, as well as additional start-up costs in the first period.

Figures table

Lean Financial Model

RevenuesThe revenue section has three lines to review all generated money before calculating the total for each period. The first aspect to consider is the € per sale – the amount of money received from the customer, for a product or service. The second line focuses on the number of sales you expect to make in each pe-riod. The € per customer – the money made per customer - can then be calculated by subtracting the € per product (costs section) from the € per sale (revenue section). By multiplying this figure by the num-ber of sales, it’s possible to calculate the total revenue you predict to make over the three year period.

Referring back to the shoe shop example, the € per sale figure is the average sale price of the shoes based on the manufacturer’s suggested retail price (MSRP). This increases inline with the KPI maximising margin per customer and as the value of the shop increases over time. Here, the number of sales is the same as the number of customers given our definition that a customer is a purchaser of a pair of shoes. The quick calculations have been carried out to complete the section giving a view of the total revenue.

Figures table

Lean Financial Model

ProfitThe final part of the LFM is the moment you’ve been waiting for – is my business going to make a profit? The Margin per customer is calculated by subtracting the CTS per customer (costs section) from the € per customer (revenue section). This highlights the overall money made from each customer and ideally should be positive figures! Finally, the total profit line can be calculated by subtracting the total costs (costs section) from the total revenue (revenue section), giving a clear indication of the future profit of your business.

For the shoe shop example, the calculations show that even in quarter two of year one, €13 profit will be made per customer and this figure increases with time. Whilst the company is expected to have more outgoings in the first half of year one, it will generate positive profit by the third quarter and will deliver significant financial reward by year three.

Figures table

Lean Financial Model

Example

Lean Financial Model