You will stay poor if you don't understand this equation Ep 346

Alex Ramosi, host of the podcast and owner of acquisition.com, emphasizes the importance of high-quality data for entrepreneurs to make informed business decisions. He introduces two fundamental equations essential for understanding business growth and profitability. The first equation involves sales velocity, lifetime gross profit per customer, and hypothetical max revenue, which helps identify if a business is growing, shrinking, or at equilibrium. The second equation calculates the lifetime gross profit per customer using price, margin, and churn or number of purchases. Ramosi illustrates these concepts with real-world examples, demonstrating how these metrics allow business owners to make strategic decisions about marketing spend and customer acquisition costs. He encourages entrepreneurs to familiarize themselves with these equations to effectively analyze and grow their businesses.

• High-quality data is critical for making good decisions in business.
• Poor quality data leads to poor decisions and undesirable life outcomes.
• Entrepreneurs must understand basic business equations to be successful.
• Knowing key business levers helps in making prudent decisions.

"And if you don't have high quality data, then you will have poor decisions and you will not like the life that you end up leading."

This quote underscores the direct correlation between the quality of data and the quality of life resulting from decisions made based on that data.

• Understanding business equations is essential for analyzing business decisions.
• Knowledge of equations helps in identifying bottlenecks and necessary actions for a business.
• Equations are tools for interpreting business growth, shrinkage, and equilibrium.

"And so one of the important skills or attributes that I believe successful entrepreneurs have is in understanding the basic equations of business."

This quote emphasizes that successful entrepreneurs distinguish themselves by their grasp of fundamental business equations.

• The equation involves three variables: new sales per month, lifetime gross profit per customer, and hypothetical max revenue.
• This equation can indicate whether a business is growing, shrinking, or at equilibrium.
• Understanding this equation enables prediction of business performance and future growth.

"So this equation has three variables in it. One is the number of new sales per month, which most people know. The second is the lifetime gross profit per customer, which most people have no idea. And then the third is hypothetical max revenue, which most people also have no idea about."

This quote explains the three critical variables of the fundamental business equation, highlighting the common lack of knowledge about lifetime gross profit and hypothetical max revenue.

• Sales velocity and lifetime gross profit per customer determine if a business will grow or shrink.
• Hypothetical max revenue sets the growth limit for a business.
• Equilibrium in sales and revenue indicates stability and allows for accurate future projections.

"Well, it means that at your current sales velocity and current lifetime gross profit, you're actually going to be shrinking, right?"

This quote explains how sales velocity and lifetime gross profit can predict a business's potential for growth or shrinkage.

• For recurring-based businesses, lifetime gross profit per customer is calculated using price, margin, and churn.
• For non-recurring businesses, it's calculated using price, margin, and number of purchases.
• Understanding this calculation is crucial for assessing long-term profitability.

"Now, the second is, how do we actually figure out what the lifetime gross profit is per customer? All right, so you've got price times margin divided by churn."

This quote introduces the equation for calculating lifetime gross profit per customer in recurring-based businesses, which is vital for understanding customer value.

• Understanding the lifetime gross profit per customer is crucial for assessing the health of a business.
• A high LTV to CAC ratio indicates a strong return on investment for customer acquisition.
• Businesses often struggle with knowing whether their marketing spend is effective due to a lack of understanding of these metrics.

"So your lifetime gross profit per customer is $150... if you know that it costs you $10 to acquire a customer, then you have a 15 to one LTV to CAC ratio, which is awesome, right?"

This quote emphasizes the importance of knowing the LTV to CAC ratio, with a specific example of a 15:1 ratio being excellent, indicating that for every dollar spent on acquiring customers, the company earns fifteen dollars in profit over the customer's lifetime.

• Companies often lack the necessary data to make informed decisions about increasing marketing efforts or outreach.
• Understanding whether certain numbers are good or bad is a common point of confusion among businesses.
• Speaker A aims to educate companies on understanding their own metrics through equations and examples.

"Because people don't understand, like, is this good or bad? Which is kind of funny, because you want to wait for someone else's judgment on whether or not a number is good or bad."

This quote reflects the confusion that businesses have regarding their performance metrics and the reliance on external validation to determine if their numbers are favorable.

• Speaker A discusses a case study of a service-based business to illustrate the application of business metrics.
• The business in question has a clear understanding of their pricing, costs, and sales volume.
• Gross margins and churn rates are key indicators of business health and potential for growth.

"They were selling $1,000 a month service. It cost them $100 a month, right? In cost... They had 40. So these are the numbers that we knew that they knew as of right now."

The quote outlines the basic financial model of the case study business, including their service pricing, cost, and unit sales, which are foundational for further analysis.

• Churn rate is a critical metric for subscription-based businesses, indicating the percentage of customers who stop using the service.
• The maximum number of clients and revenue potential can be estimated based on current churn and customer acquisition rates.
• Understanding these figures is essential for projecting future growth and identifying the point of equilibrium.

"But we do because 50 over 380 is your churn percentage, which I'm guessing is going to be like 13 or something like that... 923 is the max amount of clients that they're going to be able to have at this current juncture."

Speaker A calculates the churn rate and uses it to estimate the maximum number of clients the business can sustain, which directly correlates to the maximum revenue potential.

• Gross margins do not account for all business costs, and net margins provide a more accurate picture of profitability.
• A business with high gross margins can often maintain strong net margins, contributing to overall financial health.
• The case study business is projected to have a significant net margin, making it a potentially lucrative venture.

"And they have 90% gross margins right. Now, there's obviously other costs that have to go into doing the business, but they'd probably run this at, probably at 40% to 50% net margin, because if you're running 90, you can probably cover that."

This quote discusses the relationship between gross and net margins, suggesting that the business in the case study could maintain a high net margin due to their strong gross margin.

• The equilibrium point is where new sales balance out with customer churn, affecting the rate of business growth.
• Understanding this point helps businesses anticipate when growth will plateau.
• The case study business is on a fast growth trajectory but will eventually reach an equilibrium where growth stabilizes.

"Because this point right here is the point of equilibrium. It means that the number of new sales they make compared to the number of people that exit the business are the same."

Speaker A explains the concept of the equilibrium point and its significance in understanding how a business will scale over time based on current metrics.

• The host emphasizes the importance of audience engagement to spread the podcast's reach.
• Audience actions such as rating, reviewing, and sharing the podcast are crucial to its success.
• The host appeals to the audience's ability to impact the lives of entrepreneurs by promoting the podcast.

"The single thing that I ask you to do is you can just leave a review. It'll take you 10 seconds or one type of the thumb."

This quote is a direct request from the host to the audience, asking for a simple action that could have significant implications for the podcast's reach and influence.

• Speaker A discusses the maximum growth potential of a business given a certain churn rate.
• The concept of equilibrium in business is introduced, where new sales balance out lost customers, resulting in zero growth.
• The speaker uses a hypothetical example to illustrate how to calculate this equilibrium point.

"So I said 923 is the Max, right, that this thing can do. Why is that? Well, we said the churn was 13%, right? So times zero three is going to be equivalent to 120."

The quote explains how a specific churn rate limits the maximum number of customers a business can sustain, demonstrating the direct impact of customer retention on growth.

• Speaker A provides a step-by-step breakdown of how to determine if a business has reached an equilibrium state.
• The speaker simplifies the process by using a business that has not grown for a period as an example.
• The importance of knowing sales velocity and churn rate is highlighted.

"And the thing is, a lot of people don't know this number, right? Which is silly to me, but a lot of people don't know the number."

This quote emphasizes the speaker's surprise that many business owners are unaware of their churn rate, a critical metric for understanding their company's performance.

• Speaker A explains the calculation of Lifetime Value (LTV) using churn rate and profit margins.
• The significance of LTV is tied to its role in guiding customer acquisition strategies.
• The speaker suggests increasing customer acquisition efforts if the cost is significantly lower than the LTV.

"So we say, okay, well, $1,000, remember, times our margin percentage, right? I didn't put the margin in here. Let's just say it's 80%, right? Times 80%. And we divide it by churn, which is 10%, right? Which means that we're going to make $8,000 per customer, all right? In gross profit."

This quote details the calculation of LTV, which is critical for understanding how much value each customer brings to the business over time.

• The discussion turns to the relationship between the cost of acquiring a customer and the potential profit per customer.
• Speaker A challenges the business to scale up their customer acquisition if it is profitable.
• The conversation highlights the importance of exploring new growth channels when current ones have been maximized.

"A lot of people are like, well, it costs about $1,000 to acquire a customer. I'm like, great, why don't we do ten times more of that?"

The quote suggests that if customer acquisition is profitable, the business should invest more in that area to grow, assuming the market allows for it.

• The LTV to CAC ratio is essential for a sustainable business, with a minimum of three to one recommended.
• Alex Ramosi prefers businesses with a ten to one ratio, though this is a personal choice.
• Research, especially in the software industry, supports the need for a three to one or greater LTV to CAC ratio for growth.

$8,000, realistically, in order to have a sustainable business, you need to have a three to one or higher, right? It's called LTV to CAC ratio, all right? And so for me, I personally really don't look at businesses that have less than this ten to one.

This quote emphasizes the importance of the LTV (Lifetime Value) to CAC (Customer Acquisition Cost) ratio for business sustainability and growth, with Alex Ramosi expressing a preference for an even higher ratio.

• Cash flow is a critical factor when assessing business health, even with a good LTV to CAC ratio.
• Alex Ramosi uses the example of a $10 per month digital product with a customer lifetime of ten years, equating to a $1,200 LTV.
• A three to one ratio might require $200 to acquire a customer, taking 20 months to recoup, leading to poor cash flow despite a fundamentally sound business.

And a lot of this also has to do with cash flow. So imagine for a second that you had a $10 per month thing, right?...But the thing is, you might have a three to one. So let's say it costs somebody. Let's say it costs you $200. Right, to acquire this. You're like, whoo, I'm going to be rich...But the thing is, $200 is 18 months or 20 months, rather. Excuse me, is 20 months. It's going to take you 20 months to recoup off of your $10 per month.

The quote discusses how cash flow can be negatively impacted by the time it takes to recoup the customer acquisition cost, even with a product that has a high lifetime value.

• Alex Ramosi suggests strategies to improve cash flow, such as reducing acquisition costs or offering upfront payment discounts.
• By lowering acquisition costs and incentivizing upfront payments, businesses can improve immediate cash flow.
• The example provided shows a discount for the first year could lead to positive cash flow on the first transaction.

How can we figure out a way to make money getting this customer? How can we figure out a way that we can do a little bit of money kung fu and figure out a way to either decrease the cost of acquisition, right. If we can get this from 200 to, let's say, 50...Your first year is half off, right. If we know they're going to stick. So if we did first year at 50% off, then we're going to have $60 that we're going to make upfront.

This quote outlines potential strategies to improve cash flow, such as reducing customer acquisition costs and offering discounts for upfront payments, with the goal of achieving positive cash flow from the outset.

• Knowledge of LTV and how to calculate it, along with the LTV to CAC ratio, is essential for understanding a business's financial health.
• These equations can be used to evaluate businesses for potential acquisition or investment.
• Alex Ramosi mentions these are key equations he focuses on when considering acquiring percentages of businesses for his portfolio.

These are the two fundamental equations you have to know, like the back of your hand. You have to know this one, and you have to know how to calculate LTV. If you have those two equations, you can pretty much learn everything you need to know about a business on the back of a napkin.

The quote stresses the importance of mastering the LTV to CAC ratio and LTV calculation as fundamental tools for analyzing and understanding the financial aspects of a business.

• Alex Ramosi owns acquisition.com, which has portfolio companies generating about $85 million a year.
• He emphasizes the value of the information he shares to prevent his audience from becoming financially unsuccessful.
• He encourages viewers to subscribe to his channel for more insights, showing his dedication to sharing knowledge.

My name is Alex Ramosi. We own acquisition.com to portfolio companies that's at about $85 million a year. Keep being awesome, Mosey Nation. A lot of people are broke. I don't want you to be one of them. That's why I made this channel.

Alex Ramosi introduces himself and his business, acquisition.com, highlighting the success of his portfolio companies and his mission to share knowledge to help others achieve financial success.