At TGG, we believe in simplifying things whenever possible, especially when it comes to developing a basic business model. Accounting is complicated enough! One area where simplification helps tremendously is benchmarking. While every business has some unique characteristics, businesses within industries share many more similarities than differences with respect to how they make money and what range of profitability can be expected.
Simplifying and comparing to a Basic Business Model provides the benefit of benchmarking any business against the expected industry business performance at any given time. It can be broken down into the following five parts; Revenue, Cost of Goods Sold (COGS), Gross Profit, Sales, General and Administrative Expenses (SG&A) and Net Operating Income. The basic business model is a static equation, but the inputs change by industry, making this simplistic model extraordinarily powerful.
What is the Basic Business Model?
It’s a summarized look at how your business is performing. For example, below is a comparison of the ideal way a sample business should be running versus how the business is actually performing.
As you can see from this example, the business on the right is breaking even. When compared to the ideal business on the left, it’s evident that the area to focus on is Cost of Goods Sold (COGS) and to figure out why it is costing much more than the industry average to make the product. When using the basic business model, it should be viewed as a map to help figure out what to do relative to the rest of the industry and to the ideal business model.
Determining Your Basic Business Model
How do you determine your basic business model? You want to first figure out if your business is high price, high value or low price, low value. If you’re either one, you’re in a good spot. If you fall outside of this and have high value and low price, you’re going to drive yourself out of business. Alternatively, if you have low value and high price no one is going to buy from you. The first step is to figure out who you are as a business. To demonstrate, we’ll use a high price, high value and low price, low value example.
As you can see from this example, Neiman Marcus (high price, high value) and Walmart (low price, low value) have the exact same Net Operating Income at the end of the day. Both businesses are just operating in very different ways. Once you’ve determined where your business is relative to price and value, you can then start to dig in and see what your actual and ideal performance should be, so you can find out where you’re hitting or missing and take control of your business performance.