Round 2 Live eCommerce P&L Teardown with Valentin Kuznetcov

In this episode, Nathan and Val dive into a P&L teardown of a business that operates multiple D2C brands. They discuss the importance of accurately structuring the P&L to understand the business's activities and potential to generate profit. They highlight the need to separate and track components of net revenue, such as gross revenue, discounts, returns, and shipping collected. They also emphasise the importance of transitioning from cash accounting to accrual accounting and the challenges of accurately tracking cost of goods sold and inventory. They discuss the significance of tracking transaction fees and the need to allocate them correctly. They also touch on the importance of segmenting advertising and marketing expenses and the benefits of using buckets to categorise expenses. In this conversation, Val and Nathan discuss the importance of understanding and optimising the financial aspects of a business. They explore topics such as gross margin, operating expenses (OPEX), marketing expenses, and the impact of personal expenses on the P&L. They emphasise the need for businesses to make strategic investments and allocate resources efficiently to maintain profitability and long-term success. They also highlight the challenges faced by online retailers who stock other people's products and the need for them to maximise spend per order and optimise OPEX. The conversation concludes with a discussion on the balance between reinvesting in the business and personal financial stability.

Takeaways

- Accurately structuring the P&L is crucial for understanding a business's activities and potential to generate profit.
- Separating and tracking components of net revenue, such as gross revenue, discounts, returns, and shipping collection, provides valuable insights into the business's financial performance.
- Transitioning from cash accounting to accrual accounting can be challenging, but it allows for a more accurate understanding of revenue and expenses.
- Tracking transaction fees correctly is essential for making informed financial decisions.
- Segmenting advertising and marketing expenses and using buckets to categorise expenses can provide clarity and help with decision-making.  -- - - Understanding and optimising the financial aspects of a business is crucial for long-term success.
- Gross margin and operating expenses (OPEX) play a significant role in determining a business's profitability.
Marketing expenses are often high in the direct-to-consumer (D2C) space, and businesses need to find efficiencies in other areas to maintain profitability.
Online retailers who stock other people's products should focus on maximizing spend per order and optimizing OPEX to improve gross margin.
Strategic investments and efficient resource allocation are key to building long-term brand equity and staying ahead of the competition.
Business owners need to find the right balance between reinvesting in the business and personal financial stability.

Chapters

00:00 Introduction and Background
02:12 The Importance of Accurately Structuring the P&L
03:38 Tracking Components of Net Revenue
06:08 Transitioning from Cash Accounting to Accrual Accounting
09:25 The Challenges of Tracking Cost of Goods Sold and Inventory
12:31 The Significance of Tracking Transaction Fees
15:22 Segmenting Advertising and Marketing Expenses
33:27 Understanding the Impact of Fixed Costs on Profitability
36:10 The Significance of Gross Margin for DTC Brands
37:20 Challenges Faced by Online Retailers Stocking Other Brands
38:30 Maximizing Spend per Order and OPEX Optimization
41:15 The Shock of Marketing Expenses in the D2C Space
44:29 The Regression to 0% Net Profit and the Importance of Innovation
53:47 Minimising Noise and Adjusting for Personal Expenses on the P&L
58:15 Balancing Reinvestment and Personal Financial Stability

Transcript

0:03

Welcome back to the podcast. In this episode, I'm joined with Val again. We're to be doing a P &L Teardown round two. The last podcast that we recorded, Val, was the highest viewed best performing podcast we've ever done. And I went into it with the expectations of it being the most boring podcast we would ever do. But it turns out I'm wrong. So here we are again. Thanks for coming on, Val. You've obviously brought a P &L for this one. We'll dive straight into this. Absolutely. Yeah, I think it's my magic. I tend to make finance fun. Tune in. outside. Perfect. Well, this time we've got another P &L that we've fudged numbers of, but the reality, the structure, the representation of the P &L is reflective of the real case. So it's not like, you know, there's going to be some significant changes done to the P &L, but it will deliver the main idea of the business and also give us something to talk about. I'm going to share my screen now and we'll take a deep dive. All right, so it's another QuickBooks P &L and next time I'll probably get a zero P &L. But this is a business that, to give you some context, is a portfolio of several D2C brands. And they're tracking all of the brands together in the same P &L format without any segregation, which is something that we will discuss. And they're also in the... arts space of D2C in the category. And we'll talk about some of the implications of that niche and category. Before we talk about the specifics of the business and the technical side of it, let's talk about the P &L structure one more time because I think this is by far the most important starting point for any financial statement or financial overview, financial management. When we look at the P &L, it has to convey specific information about the business's activities and its potential to generate profit, make money for an investor or for a brand owner. Because again, at the end of the day, the goal of any business is to generate cashflow for years to come at minimal risk. And of course, P &L is part of that cashflow, free cashflow. you could say. And we've to make sure that whenever we look at the P &L, we can extract specific information that will help us generate more cashflow for years to come at minimal risk. And when I look at this P &L, it tells me some story of the business, but not a complete story of the business. And that exposes me to a lot of risk, right? So again, part of the journey is to generate cashflow at minimal risk. And when I don't understand what happens in the business, at what level, to what degree, if it's accurate or not, if the information presented to me accurately, that's a lot of risk that I'm taking on. That's why structuring your P &L in the most accurate and informative way is the number one step before you proceed to any financial management. So when you look at this P &L again, some of the things that I pointed out on the last part is the revenue separation or segregation. We want to look at all of the components that make net revenue. And to be specific about that, that's typically your gross revenue, your discounts, your returns or refunds, and your shipping collection. Sometimes you can collect import duties and taxes if you ship internationally, but if it's not the case, you don't have to have a separate line on the P &L. But this is the level of breakdown that I always like to see. And the reason for that is because all of those components determine demand for the product and overall net revenue. So sometimes brands over discount products or there is a spike in refunds and returns for whatever reason after a specific product launch. If we don't split that out in the net revenue or net income section, or sorry, not net income, but the income section here on the P &L, then we don't know how much we're discounting, how many refunds we're processing, how much shipping we're collecting, and whether... the shipping that we're collecting from our customers actually covers the cost of shipping that we incur on the back end. And if it's not tracked at that level, then we may not be making the right financial decisions in our business. So the number one step is to take a look at that income section and separate it into its components. Again, we don't want to have... over -detailization, right? We want to have the right amount of information for us to make decisions. And something that I should note as well is that this specific P &L is also cash basis. So you can see that revenue is not recognized as it's earned, but as payments or deposits from Shopify are processed in the bank account. So you can see that these are all deposits from Shopify that are recorded on a regular basis, daily basis, whenever they are deposited and reflected as revenue, which is not exactly accurate. We want to follow a cruel basis because, again, we want to have the most accurate understanding of how much revenue we make on what days, on what weeks, and how that's translated into components. So to get you off there, I was just gonna hop in with a question, which is one that I got from a client last week, being a business is currently on cash accounting. How hard is it for them to make that transition to accrual? comes down to processes and technology that they use. For example, to have that sort of segregation in QuickBooks for Xero, you could use... data aggregators like A2X, for example, that will take data from Shopify and pass it through to QuickBooks or Xero in that detailed format. So it will break down discounts, refunds, returns automatically. You don't have to do it manually and then you can match the information. So at the revenue level, it's pretty straightforward to make that switch from cash to accrual. However, part of accrual basis is also cost of goods sold in inventory. That's where the challenges begin because unless you have proper inventory management in place, you will struggle to have the most accurate accrual basis in your business. Good to know. Yeah, so if you guys have any questions, you can reach out to me directly and I will guide you on the specifics of the transition. And something to note as well is that there is a common misconception that when you switch from cash to accrual, that affects your tax submission. It doesn't. If you follow accrual basis, you naturally, by default, follow cash basis as well, because in the accounting system, there is an easy... filter or mode to switch from accrual to cash basis. But if you only follow cash basis, you can't switch to accrual basis because there's just no accrual. So accrual basis will recognize cash transactions as well. And you can easily switch from accrual viewing mode to cash basis. So for internal purposes, you should be using accrual basis, but for tax purposes, you should be using cash basis because again, there is a lot of cash. cash advantages or tax advantages on the cash basis. Since we tend to, as D2C brands, we tend to invest a lot in inventory upfront, which is a cash outflow that we could write off against our taxes when we follow cash basis. So again, is a, you can still use both and I recommend to use Accrual for internal purposes. Yeah, so what I heard there is that even a beginning DTC brand who's doing zero dollars in revenue, they might think that they should be on cash for the tax saving purposes, but really they can set up on a crawl and still get cash visibility and then use that within their tax returns. Precisely, So internally, with your accounting, you should be doing accrual basis, but then in terms of tax filings, you can do whatever you want, right? It can be either cash or accrual basis. You just have to discuss that with your tax accountants. And then once you follow accrual basis, you will easily switch to cash basis as well. Good to know. Make sense? Cool. So let's move on before it gets too boring as well. The next section that we see is the cost of goods sold. And what I don't like about this section for this specific business is the raw materials and packaging and shipping and freight and delivery. not really being clear about what they include. So raw materials and packaging, that's fine. So that's basically the product landed cost that they process. And again, since they don't follow a cruel basis, there could be a mismatch of their revenue and cogs. Because if they're processing cogs as items are sold, but they're doing cash basis for revenue. So they're doing the cruel basis here at the cogs level, but they're doing cash basis here. that's mismatch of data. So we have to have an alignment between cost of goods sold and revenue to make sure that we know how much the product margin and gross margins are. And here they are not really splitting the last mile delivery. It seems like they're bundling shipping and freight and delivery, so all of it. And when we talk about freight, what it typically means is... freight to get products ready for sale. So you might incur international freight to ship from China to Australia or to the United States, which is cost of goods sold for, you know, to make the product ready for sale or otherwise known as product landed cost. But shipping typically is referred to as last mile delivery. So how much does it cost for you to ship an order to the end consumer, to one of your customers that would be shipping. So we want to track those separately because bundling them will distort the understanding of how much it actually costs to sell or to produce a product and how much it actually costs to deliver the product. to the consumer. And then when we look at those two separately, we can make better financial decisions because then I can see that shipping to the end consumer has been increasing for over the past few months. I should reach out to my carriers and figure out a way to structure our fees better because it doesn't make sense for us to be paying that much. Or on the other hand, I can pass the cost onto the end consumer in terms of shipping income here. So again, if we split that up, we'll know how much we're collecting from the end consumer. And here we'll know how much it actually costs us. And then we can evaluate the gap between both and make an adjustment accordingly. And of course, there's a lot of analytical tactics that we could implement. For example, looking at the invoices from our carriers and understanding what the shipping fees are by zone, by weight, by whatever it is, by different categories, by product. and then we can figure out the actual cost structure for our shipping fees in Shopify. And we can structure it that way. So again, it's a good practice to have shipping to the end consumer last mile delivery and international freight to make products ready for sale separately because they serve different purposes, they communicate different information. And again, something that is missing as well is the transaction fees. And that's because they're following cash basis. So cash basis is we'll deposit money after transaction fees are deducted. So Shopify will take their cut. and then deposit funds. And when you follow cash basis, you won't know how much Shopify is taking. And when it comes to other PayPal and other payment processes, PayPal, Affirm, Klarna. whatever it is, after pay, they also take a cut and then deposit funds. So unless you're doing accrual basis, you won't know how much you're actually paying to all those payment processors and whether you should be focusing on optimizing that because I've seen brands who spend five to 6 % of their revenue on transaction fees and they wouldn't know that unless they followed accrual basis. Do you have any questions about the variable cost section, Nathan? Now it makes complete sense. think most people always forget that transaction fees should be in your cost of goods section. And so they'll pull gross margin numbers that are actually two to 3 % off and two to 3 % on a gross margin figure is as you're well aware, huge. You might then go and allocate an extra 3 % towards marketing thinking that that 3 % exists in your P &L when it doesn't because it's being taken out at the cost of goods sold level. so having really clear visibility on that, and then the way that it's fluctuating over time too, think, yeah, it's critical to be pulling that out within, that section of the P and L and also allocating it to that section of the P and L as well. Because I think we talked about in the last video, one of the most common things that everyone does is transaction phase. Straight to operating expenses when it's not because it's going to grow or decline in direct proportion. to top line revenue, given you're using the same volume of the same split of payment processes over time. Yes, precisely. We want to understand what the variable costs are that will move one -to -one or not necessarily one -to -one, but in direct correlation with revenue so that we can get a grasp on our gross margin and know exactly how much money or profit we're making from every dollar earned. And if we should be focusing our efforts on optimizing the supply chain, the backend operations to boost that margin up in case marketing has creeped up and cost us way more. which is a nice transition into the next section on the P &L, the direct marketing costs, right? How much do we spend to generate $1 in revenue in direct proportion as well. And this is something that I talk about all the time. Advertising and marketing is not an OPEX. It's not an operating expense when it comes to paid ads and any direct form of marketing that is intended to generate revenue. But at the same time, it's not a completely variable cost because you have to pay it upfront and you don't necessarily know how much dollars it will generate especially when you scale. So it's kind of a hybrid cost, hybrid section of the P &L which is kind of variable but it's also a bit fixed. So what I typically recommend is allocating a completely separate section of the P &L to advertising and marketing which sits right after variable costs like cost of goods sold shipping to the end consumer or last mile delivery and transaction fees, but right before OPEX as well. So that section will basically go after gross profit and then right before OPEX and we will be able to estimate our profit contribution or contribution margin three. That's what it's called as well. So advertising and marketing in Xero it's very easy to set up. You can go in and custom customize the layout. So for Australian businesses, it shouldn't be a struggle when it comes to US based businesses using QuickBooks. It's going to be challenge because QuickBooks doesn't allow to manipulate the layout of the P &L so it will be a struggle but if you have it tracked separately it's still much easier to export the data into a Google Sheet or Excel where you will have a split view of what your advertising and direct advertising costs are that will drive revenue directly and then of course As a result, you'll be able to know your profit contribution, which is extremely important to know, and I'll show you why. Any specific questions, Nathan? I've only got marketing questions about this panel really on this section, which is like, are you looking closely at the relationship between spend across channels and top line revenue, which I'm sure this business is doing. But it's really nice that you get to have that clarity right there within the panel to be able to make decisions. There's a lot of context that lies outside of those figures, I'm sure. But it is still very helpful to be able to see that breakdown on a month on month and ideally on. Ideally, if you set this up correctly, you can look at the last four years of data with this level of segmentation and get actual actionable insights and see how this flows through the PNR rather than just looking at that one line item, which I know a lot of the time also sometimes includes influences and giveaways of products, et cetera, which can. really murky the numbers there. I've seen that multiple times on clients' panels where a month looks like it blew out of proportion, but it was just because they put 40k into influences as a test and it wasn't reflected. Or they gave away $30 ,000 in product to a few sports teams and it wasn't reflected. And so it's always important to have as much detailization as possible at that. advertising and marketing line item for sure. Yeah, one thing to note as well, and I would caution you is you don't want to over-detailize information that is meaningless, right? Like, for example, we can see a car and truck here, right? And it's, you know, $154 in a whole year, right? That's meaningless information that will not really move the needle. this is one of the reasons why so many founders and operators lose perspective within the P &Ls because they over -detailize it instead of focusing on the big movers on that. have a percentage rule that if it's less than 4 % of revenue, don't just group it into one grouping line item and don't have it segmented out into its own account. I would I would say, look, there are still buckets that I typically recommend and implement whenever I come in and I can show you those buckets. And then you will basically process everything within those buckets. So again, if you have an accounting firm that does all the detail ization for you, and they're happy to do that, that's fine. But ask them to create buckets for you because you shouldn't care that much about truck expenses, right? On a day to day basis on a monthly basis, especially if they're less than 1%. I would say 1 % don't even bother, right? You don't even have to worry that much about detailizing anything that is less than 1 % as a bucket, as an overall group of expenses. Because yeah, like when you say 4%, 4 % could be significant because now you're, you know, if you're wasting a ton of money there, you should understand where exactly it goes. But again, it's all about grouping all of these expenses together. For example, like meals and entertainment and travel. These are what I call miscellaneous business expenses. So you can group them together, right? It's just other expenses that could be incurred once in a while. They're not really recurring. but we still incur them or they could play a significant part in your business specifically. For example, if you are a trade business that has to go around and see a lot of trade shows and attend a lot of trade shows, meet a lot of new people, then travel becomes a significant portion of your business. But for D2C brands specifically, that shouldn't be a concern whatsoever. So you can group them together under one account called miscellaneous business expenses. and not worry about it. Car and truck, if you use car and truck for business purposes, again, miscellaneous business expense, right? It's just there as an expense. You're not really spending too much money, less than 1%. Shouldn't worry about it too much. Focus your efforts on detailizing things that actually add up to a significant portion of your revenue. Like you said, influencers, Understanding how much influences are is critical because influencers is one of those expenses that is not direct either. And it's not a fixed expense either. And there's a lot of debate about how you should be categorizing influencers, for instance. I typically do it as an indirect marketing expense because I believe that influencers serve a more branding purpose rather than revenue generation purpose. If revenue comes with influencers, great, right? But we don't really, we can't really know exactly how much revenue we're going to generate, especially if it's a... influencer that we are doing the push for the first time with. So it's more of a fixed cost rather than a variable cost like paid ads, for instance. So it's closer to being a fixed cost. But again, there's that's where accounting becomes more of an art form than a science because there's rules of course, but accountants follow their own rules. We as decision makers have to create our own rules because there is no one specific format to build your P &L in, but you want to have proper oversight of big chunks of your business, of your P &L in a way that actually adds value and communicates information. Yeah, we even do this internally on our own P &L, which is that we break our own P &L down in terms of operating expenses into four core buckets in zero export, which is software, staff amenities, general wages, and fixed. And so that gives us really good visibility into those four buckets and how we need to be controlling them over time. I really like having SAS segmented out because SAS, as much as it is deemed a fixed cost, it is variable with revenue, unfortunately. And that's the case with the whole SAS model, which is that as you grow, SAS costs will likely increase. And so even just having that segmented out, I do really like for being able to visibly see how how much you can tangibly control OPEC's not inflating and actually being able to open your margin at scale. Absolutely. That's a very smart move. And then when we talk about this specific business as well, you can see that they have their own way of tracking advertising and marketing expenses, for example. They want to see the contractors, the subscriptions related to marketing specifically split out separately, which is something that I don't typically recommend. And the reason for that is because we want to have all subscriptions together. So the idea is, let's say here they have advertising subscriptions, here they have operational subscriptions like inventory management, accounting, so on and so forth. So they're separating subscriptions into separate buckets. I don't recommend doing that. I typically recommend doing... overarching cloud tools and subscriptions and then underneath it you can split it into advertising or operational subscription. So that's where the structure becomes different and communicate different information because here they're taking an advertising marketing approach. First, I'm taking a more Alpex buckets approach, right? So we spent a total of $20 ,000 a month, for example, on cloud tools and subscriptions. But then you can see where exactly that money goes. Is it advertising? Is it operations? Is it whatever it is. You can create any labels, segments, customer service. You can do, you know, Gorges or Xendesk split out separately, loop returns, so on and so forth. So there's plenty of ways you can structure it, but I recommend taking the bucket, OPEX bucket approach. where you have set buckets and again I can show you the list of those buckets that I recommend and then underneath those buckets within those buckets you can split it out to whatever you want but I don't recommend doing this type of setup. And I understand why they're doing that. They're trying to measure the overall marketing effectiveness, right? So everything from direct marketing to fixed marketing expenses. What is the total amount? And how much is that as a percent of our revenue, which is marketing effectiveness ratio, whereas marketing efficiency ratio only looks at the direct portion. So how much is our Facebook or how many dollars or X multiples do we? get back on $1 spent on Facebook, Google as a blended performance. Hopefully that was clear. Yeah. that's fascinating because I've actually been tying that up in my own head over the course of the last three to six months in terms of our own P and L and sort of relating this to a different company structure. P and L is I've been thinking about how SaaS could be split up into a sales and marketing cost because you have your CRM and that's very much so a sales and advertising cost. If there wasn't sales and advertising as a function within the business or it was downscaled that would remove or would variably change. And then the same thing with service delivery in an agency, you have a few core SaaS products that scale as clients scale. And so I was thinking about looping that into cost of delivery as well to have a variable gross margin that's more of a direct reflection of the costs of delivering the service. It's interesting that you prefer having it in the operating expenses and then just bucket within OPEX. Yeah, and the reason for that is because it simplifies the understanding. Again, I believe that the goal of P &L is to show your revenue, to show your variable costs, the hybrid cost of the direct marketing, and then your fixed costs, right? That's the starting point or the initial purpose. And then you can do and manipulate the PNL however you like. You can then export the PNL out of your accounting system, import it into Google Sheets, and then create whatever manipulations you want. But if you start messing around with, for example, again, here with advertising and marketing, they're bundling both direct and indirect marketing into one account, which I don't believe is correct. Because again, these expenses do not drive marketing directly. So saying that all our you know, we spent $357 ,000 on marketing to drive this much revenue is not exactly correct because if you remove these contractors or subscriptions, you shouldn't really have a drop in performance, or at least it shouldn't be as significant, right? Of course, if you have a great marketing advertising agency on board like BlueSense Digital, then of course you might experience a significant drop. But I would say that if you're Agency does a great job in setting you up for success removing them should not have significant drops in performance So we can't argue that three hundred fifty seven thousand dollars was spent to generate this much revenue for example again assuming that this is a cruel basis three hundred forty three thousand dollars because we actually spent or we might have spent much less or half of that on the actual paid ads to drive revenue and the other half on contractor subscriptions. And again, we can't tell for sure because they used to bundle it all together, but then they switched to this detailization format in Q4 2023. So you can see how important it is to have that split, right? Because now we're assuming that we're spending $357 ,000. every month to drive $343 ,000 in revenue, which is not correct because it's likely much more efficient on the paid -out side, but not as effective as it should be on the fixed side. And the reason for that is because this is a seasonal business and we can see here, it's another point that I wanted to make. You can see the fluctuations here in their revenue, which are pretty significant. I'll zoom in here. You see how they pretty much go from $103 ,000 in revenue up to $2 .7 million in revenue in May. That's a huge spike, right? So there's a lot of seasonality and that's why understanding how much your fixed marketing costs are, your contractors, your tools that you implement to drive marketing efforts, your... Personnel your agencies contractors anyone who is involved on the fixed or recurring basis has to be tracked separately because then you can make decisions on when to schedule labor or cut agencies or restructure your arrangements with agencies Especially when you are seasonal business like this because again, they can't afford to run huge fixed cost bill in Months that they're losing money or not making as much right so we got our understand the baseline of fixed costs and then we've got to understand the performance of our direct marketing efforts so that we can move forward with profit in mind. Perfect. So on the OPEC side, there's nothing really to unpack here. Again, there's a lot of unnecessary utilization that can be bundled together and I will show the buckets now. So let's have a quick look again. This is a quick reminder of how I typically recommend to split the P &L. So let's zoom in. Again, we want to have the split of net revenue into gross sales, discounts, refunds, shipping, collected. So for this business, have $8 .1 million in net revenue. Their cost of goods sold is, again, that's everything. That's all your shipping and fulfillment transaction fees, freight, all of it is bundled together, which is why I just call it a COGS for the sake of this exercise. So they're, and again, they're shipping and fulfillment transaction fees is what I told you. what I typically recommend to split as well is at zero because they're not tracking, cetera. So it's all in here in this COGS line, which basically means that their gross margin or contribution margin too is 79 .8%, which is an amazing gross profit margin, right? So they can go out and do a lot of marketing activities and lose a lot of money on marketing and go out and capture that demand or create that demand because they have... such decent gross margin. Now on the paid ads you can see that they're spending quite a bit of paid ads and again this is all when I look at it for simplicity I just kept it at this total advertising but of course there is a fixed portion to it as well so which is something that we should be removing but I did this analysis for 2023 only which doesn't have a split that's why I kept it all together. So just assume that there is a chunk of fixed marketing cost that is bundled with direct marketing in here as well, which is something that should be removed. So when we look at this figure, we see 50 .9 % in MER, marketing effectiveness ratio, which is not really effective, right? But it's good that they have such a good gross margin because they can afford to run this type of marketing effectiveness ratio. So they can go out and spend a lot of money, experiment a lot, and... you know, be as ineffective as the gross margin permits. And again, the reason for that is also the seasonality aspect, right? They have a lot of fixed costs that will eat into their profitability in months that they don't generate a lot of revenue, and they only rely on very expensive periods of the year to generate revenue, which is why they're Performance drops dramatically. So they have to run ads during Black Friday, Cyber Monday, know, the Valentine's Day, Memorial Day, whatever the holidays that they generate the most output in, which are extremely competitive and will eat into profitability. So it's natural to see that type of MER for this business. But on the OPEC side, they're doing quite a fit. efficiently. They're very efficient and lean business. 16 .5%. I would say they could probably go lower as well than 16 if they can better manage their OPEX during lower seasons. And again, it's probably closer to 20 % because part of the OPEX is included in this paid ads chunk. There's still some room for optimization. I would argue that it's better than most brands if it's 16 .5%. If it's closer to 20%, they're pretty much an average D2C brand. But I would say that for any D2C brand at this scale, we should be looking at 10 to 15 % if they're doing things right, because there is no reason for you to have... OPEX of 20 % when you're doing $10 million in revenue. And I know this is a very controversial take, but I believe that businesses with 20 % at$10 million are doing something wrong. Like you can't, you know, the purpose of the DTC is to have that profitable scale. And if you got to $10 million, but you're still spending a lot of money on OPEX, it's not really an investment as a step up cost for future growth, then you just have poor operations and backend systems in place that force you to overpay and overinflate your OPEX. So with these guys, they're pretty much on the brink of being an average business and quite inefficient, but... Again, we have to dive into the OPEX breakdown, understand if the costs are being tracked properly. again, considering the seasonality, it's actually okay for them, but there's still some room for improvement to optimize OPEX and make sure that they're not wasting cash. But overall, they're still sitting, even considering 16 .5%, they're still sitting at 13.7 % EBITDA, which is very strong for business. And they can reinvest all that profit back into the business. And this is something that I've been pushing for. One of the best predictors of success for any DTC brand is their gross margin. ideally, I want to see a business doing 70 % plus gross margin, which is... You know, it seems unrealistic in the current landscape, understandably so. Five years ago, businesses had 60, 65 % gross margin and had an EBITDA of 10 to 15%, but that's because their marketing was not as expensive. Now that marketing is extremely expensive, super competitive to advertise, you've got to understand that your MER will likely be 25 % minimum. and probably closer to 33 % on average. And for some businesses, it can go as high as 45, 50%. So with that in mind, you have to realize efficiencies somewhere else, which means that you have to have the backend sorted out. You have to have that backend scalability and efficiency to have solid margins that will allow you to advertise and spend money on advertising to remain competitive. And I'm pretty sure that's something that Nathan will attest to as well. Yeah, absolutely. I have one question off the back of it, which is gonna be a tough one. What do you have to say for online retailers who are stocking other people's products? I know you've worked with a couple who are pretty big as well. Very hard to have CM1 really above 40 % if you're retailing other products. I know that you get efficiencies in marketing because you're not generating demand through marketing with these types of brands. You're instead capturing existing demand that is generated by the brands, or at least if you're doing a good job as a retailer, that's what should be happening because you should be stocking products with the products that you're stocking. The original brand there was going and pumping ad spend and generating that demand for you. But outside of that, what do you have to say for baseline? contribution margin numbers for retailers. Yeah, there's two points to take there. So if you're carrying other brands and naturally there is going to be not a lot of margin to work with. You have to do two things. One is you have to maximize the spend per order because that will boost your gross marginal together. So if you sell more items in the same order, your shipping and fulfillment will only cost you marginally more, right? It's not going to be too much. When you look at each extra or incremental unit that is added to the cart, it only incurs marginal increase in costs. For example, it could be a pick and pack fee per unit, right? Depending on how you structure your relationship with the 3PL, if you work with 3PL, or it could be... you know, your carrier fees. So carrier fees, again, the weight doesn't really change after a certain threshold. It doesn't change too much to incur more in costs, which is why adding for, you know, incentivizing people to spend more and add more items to the cart will boost your gross margin simply because of the efficiencies on the last mile delivery costs. That's one of the keys. The second thing is OPEX. So if you're, if you know that you're building a brand with with as a reseller of other brands, then you have to be extremely efficient because you're coming into the game with tight margins from the get -go. So you have to build with backend in mind and build so that you can maintain volume, right? Because again, with tighter margins, it becomes a volume game. You have to generate a lot of profit contribution dollars to stay profitable. And when you keep your old pegs lean, with scale and with volume, your OPEX will become less and less of a percentage of your revenue that you generate. And as a result, you will ultimately generate more profit contribution than your fixed cost for OPEX and now will put more money in your bank account that can be reinvested back into the business. So that's the two key things. Again, it's when you're a reseller, marketing is sort of a given or a random. You can't really control it as much. You have to control your gross margins through proper discounting and offer structure. And you have to control your OPEX and stay as lean as efficient as possible. Mm -hmm. I've got so many questions to throw at you, but the thought that I just had then was what I find a fair bit, and maybe you found the same thing, is... those that come from brick and mortar, those business owners that might have been business owners for 20, 15 years, and they come from a brick and mortar presence and they move into the direct to consumer space, whether that's that they have an existing business, they make an omni channel, or whether they actually just create a new direct to consumer business on the side. there's this real disconnect or almost shock at how much percentage of revenue you have to allocate towards marketing to get a direct consumer brand off the floor. Because if you're running brick and mortar, the marketing is built into the operating expense line item being your rent. Normally you're renting in a place where you're getting foot traffic and that is the advertising and marketing. And so you don't actually have to go out there. and get this extra chunk into the P &L that didn't used to exist. Do you say the same thing? Sir, can you repeat the question? Do I what? Do you see the same thing amongst those kinds of business owners transitioning from brick and mortar? Do I see them as surprised? Yeah, I mean, I'm surprised how much it costs to advertise in D2C now. It used to be way cheaper and it doesn't make sense anymore, But I'm sure, yeah, I'm sure that it's just a conceptual or contextual rather, contextual perspective. You just look at it and you're like, wow, I never knew that it was that expensive to compete against other brands. who sell the same thing, right? And yeah, that's what the internet has done. It's it's expanded the number of options for people. At a click of a button, you can access hundreds of other options, whereas brick and mortar, if someone lives nearby and they go to that same brick and mortar store, there's only really one option to shop for. And that's what the internet has done. Expanded the playing field. It has added a lot of players. And as a result, the competitiveness has gotten out of hand and brick and mortar stores don't understand that competitive aspect because there's not a lot of, you know, construction going on on the opposite street with the exact same product line or exact same product. So yeah, I think it's just, it's just indicative of how commerce is evolving and changing and some other aspects of the P &L will go through the roof. Like for example, in the future, we could see that the payroll goes down significantly, right? Because we will switch to AI and automation and then people will wonder, well, how did businesses incur such a heavy payroll or salaries and wages before? So it could evolve into something else with AI and the cost of OPEX will go. even further down. I hope I answer your question. But yeah, I do see a lot of brick and mortar store surprise, but I think it's all about the evolution of commerce and how, you know, some aspects of it will evolve and dictate the rules in the in the landscape. Yeah, you said that even you were surprised at how expensive marketing has gotten as a percentage of the P and L. And I have this theory, which I think I've said a few times on random pieces of content here and there, which is that I believe that every business is, every business regresses to 0 % net profit. I think the free market sits every single business that enters into it at 0%. There's no margin. And then Over time, what happens is businesses enter and they have a point of arbitrage within the market. And that's what gives them the ability to get that 10, 20, 30 % net. But then over time, there is this entropy that exists that naturally corrodes that margin back down to zero until there's a new arbitrage discovered within the market. Some people maintain the net forever through branding, but that's about it. Hmm, that's very interesting. I think it's a huh But then what you're saying is your long -term investments have no value whatsoever. So basically any capex that you're because again like What you're doing is let's say I allocate a budget now, which is expensed now But it's really a long -term investment in my brand, right? What you're saying is that investment has no merit whatsoever because the market will always adjust to whatever performance you have going on. But I think it's the investments that you're making in the business, whatever that might be talent, processes, systems, branding, they will stack over time and they will create that additional value. And that's how markets grow, right? Because markets grow from investments, not expenditure. contrary to everyone's belief, right? When you think about it, if everyone just spends, spends, spends, which is expenses and the arbitrage that you're talking about, then yes, the markets will always self -correct. But, you know, good economies, when they make the right investments, they will grow. no matter what, There's no like, it's not because of arbitrage. It's because of long -term investments that are stacking on top of each other. So I would say, yes, if you were just a business oriented on expensing and just spending something to get back, at some point you will be... you know, exposed to arbitrage in the market and you will fall victim to the efficiencies and inefficiencies and the corrective forces, the invisible hands, so to speak, right? But if you're a brand making investments in your business and you know exactly what drives value over time, you will stack all of those investments and it will accumulate into equity or shareholders value, right? And I think that's what is important for businesses to understand. You got to have that investor mindset. What do we need to do now to take our dollars that we may be generating from arbitrage at the moment, but how do we take those 13 .7 % generation? Yeah, I can still probably spin a narrative and say that with investment into the business, you're just increasing the complexity of the arbitrage required for other people in the market to grab that from you. And so maybe I'll give an example of, and I'm always pulling away to DTC because it's easy for me to go agency side, which is let's say your agency side and you. Get a squeeze because you have incredible retention. That does wonders for a P &L if you can not churn clients because then you don't have to allocate any expenses to marketing and advertising. Over time, people should realize that we'll start getting really good retention and then we'll also market and advertise and therefore squeeze you out of the market because now they've taken your margin and used it against you. And so I think you're sort of just trying to stack an edge within the free market consistently, and you're constantly battling that regression back to zero that all of the competitors are going to push you towards unless you continue to innovate, which I think reinforces your argument, which is innovating and continuing to allocate investment strategically is the only way that you survive over the long term. Brands that just think they can grab a product, it online and cool. That's like maybe, like maybe for six to 12 months, if you found a really good opportunity within the market, and that didn't exist. Because what if you're selling a product that I can get off Alibaba for $3, and you found it, you started selling it. And by the way, we work with, we have worked with quite a few brands that do this, they find a product, they go, no one's selling this in Australia, they start selling it. And cool, they're running at 90 % gross, and they're doing really well. But all it takes is anyone, I could do it. to go to Alibaba, spin a website up for $200 and arbitrage that margin straight down because now I'm bidding on Google, now I'm bidding on Facebook and now you're slowly getting squeezed. I don't think people foresight that enough and they don't do what you said, which is invest into building long -term brand equity in some capacity. absolutely. I think what you just said is, is a perfect recap of that. And dropshipping businesses, dropshippers are the best example, the brightest example of arbitrage opportunities, right? You don't hear too much about dropshippers anymore. Well, that's because the cost of advertising has gone up and it's not as lucrative anymore. You don't make that much more money. On the other hand, we talk about brands like, you know, let's say Apple, right? People still go to them and that's because they used to be an innovator. So they invested in innovation. They created a completely different look at how you should work and how you should interact with technology. And as a result, that's an investment that was made back then that is still paying dividends. And there's no amount of arbitrage. It doesn't matter who comes in and tries to fight them directly. The branding is so sticky. The product is so sticky. They made the right investments back then. They're still carrying the brand. It doesn't mean that they can go on forever like this. Of course not. But there is this longevity that is created with the right investment that will buy you a certain amount of time, no matter what the market's rules are and how. Because again, dropshippers have come and gone. Apple is still here, right? Still here, still selling, but there's probably been some, you know, dropshippers who sold, used, you know, I don't know, iPhones or whatever technology through the websites, right? Again, I think it's an interesting conversation and we'll probably go on for it for a long time. And maybe we should have a separate podcast to discuss it, but... Yeah, I think if you're a brand who makes the right investments, you should be totally fine. Yeah, the last thought that I'll pull on the string here and then we'll move on is I feel like as a business owner, you have to have the mindset of that you're constantly fearful that the market is going to catch up. even like I could take ourselves like there where we currently have arbitrage in the market in my opinion is that we invest so incredibly heavily into learning and development within the team. And we are constantly trying to push that and do it better than everyone else, which results in better than everyone else's performance marketers. And it results in the arbitrage that we get. And that sprinkles out into everything else. But if I just operate that no one else will ever do that. Well, how long do we have? Maybe we have a year, maybe we have two years. Other people are going to figure it out and then start doing it because we clearly have a huge advantage in the market. And then when other people start doing it, what do we do? And so it's having that foresight to think ahead and being in this scarcity mindset of everyone's always going to catch up. We have an advantage now, but it's not going to last long the second any smart operator catches on and starts doing what we're doing. And so how can we innovate now so that we're two steps ahead or three or four? and continue to allocate capital efficiently and effectively. Yeah, absolutely. That's the name of the game. Allocating limited resources into areas that will buy you that competitive advantage and stack the value over time. Exactly. So, one last side note that I'll add before we wrap this one up. Back when you had the, P and L there was obviously that car line item there. I think we alluded to it in the first podcast, but I also just want to get a clear answer on this, which is a lot of business owners, particularly let's call it one to 10 million. There'll be stuff on that P and L that have nothing, maybe nothing to do with the actual operations of the business. Maybe they do it, but maybe they don't. skews the data, skews your net profit numbers. And I often get given net profit numbers and I look at them and I go, this is definitely not your net profit. There's stuff in here that shouldn't be in there. How do you adjust for that? And when you're working with clients, do you adjust for that? If so, is it an easy fix? Is it hard? How would you go about that step by step? Yeah, I typically observe that with smaller brands and simply because it's a one man operation more often than not still like trying to figure things out and expensing everything. And again, there there's two realities. One is internal accounting and one is tax accounting. So I understand why businesses are writing everything off as an expense to bring their taxable income down for tax purposes. Continue doing that. But Allocate a separate section on the P &L which says personal expenses that goes right after, you know, your EBITDA. So you can basically track your business performance, business operations, and then you can see the impact of your personal choices or lifestyle onto that business and just make decisions that way because at the end of the day, the internal P &L serves you, not other partners or whoever else. it's important for you to understand, what if I start paying myself a salary? How much should I pay myself? When you look at that breakdown of personal expenses, how much you're taking out of the business on a monthly basis, you will have an idea of how much you should be paying yourself or how you should be adjusting your lifestyle to fit your business's at the moment, or performance rather. Yeah, that's good to know. That's exactly the approach that I recommend to our clients, which is to have it bucketed in some way, have a custom zero export. You can pull all of those line items in, you can make an EBITDA adjustment, and you can get a realistic reflection of what the business is actually operating on. And the reason why I say that, and the reason why I think it's good to wrap this podcast up at that point is that I see, this might surprise you, maybe it doesn't, but I see a lot of business owners freaking out, stressing out about how low their net profit number is when there is zero consideration of owner's compensation and three, four, five, six, $7 ,000 a month in write-offs on that P &L. And it's actually a very different position as to how they're getting compensated through that business. But because they don't have an intimate understanding of P &L structures, which is why I think these podcasts do so well, as well as financial operations, that they feel the pressure when they shouldn't necessarily feel the pressure. And so even though it's such a small thing, I actually think it's really important in these two to $3 million businesses that they get clarity on what compensation is actually flowing through from the business because it looks bad when your accountant puts that cash P &L together, but in reality, it's a lot better of a story. Agreed, agreed. Yeah. And it's all about behavioral finance, right? Understanding that, your business is here to serve you, but at the same time you've got to, it's a trade off between short -term gains and long -term longevity, essentially. So yes, you can pay yourself now a lot of money, but if that affects your business's cashflow, it could undermine the business's ability to provide for you financially in the future. So it's always a trade off of how much should I be taken out and should I be stressed about my finances? And when you have a clear structure, like you said, it will definitely help you make the right decisions and understand because I think a lot of business owners have an answer. They just don't know the tools to help them minimize the noise. And part of noise minimization is proper P &L structure, understanding what each of the sections tries to convey, and then split the personal and business activities separately and know exactly how much of an impact your lifestyle, personal lifestyle has on business performance. I think that'd be a great topic for a follow -up podcast because I think a lot of business owners, that is the hardest dichotomy to try to answer, which is how do I balance reinvestment into growth of the company versus am I eating beans and rice or should I be comfortable or should I be very comfortable? And no one really knows where to sit, but there's always a sweet spot. know it's going to be very nuanced depending on the individual business and their position, but I did hear a really good quote a while ago that stuck with me, which was that you don't want your personal finances to become an issue of the business's finances. And so you want to make sure that you're not crippling the business, whichever way that is, whether that's that you're taking too much capital out and not allowing the reinvestment or whether that's that you're taking none out and you're stressed as hell all the time when you could find more of a middle ground. So maybe we'll loop back to that one in a follow up. Yeah. Yeah. I, to end it with one more quote for you. I, I wrote this down ages ago, which is that, scaling a business profitably is like peeling the layers of illusion that lie over reality. And the more layers of illusion you can get rid of, and the more crystal clear you can see reality, the easier you can navigate business. I thought that was because there's so many human biases that are built into us. Yeah. Yeah. Anyway, let's, let's leave it there. I know you've got, you got a few things coming up, so you might as well announce them, plug them. I'll make sure they're all in the description below on YouTube, on Spotify. Fantastic. I couldn't recommend the cohort enough. I don't think most people realize, probably 90 % of my finance knowledge and my ability to align finances with marketing actually comes from Vell. We've worked really closely over the last six to 12 months. I also paid about $50 ,000 for a finance degree. And I have learned about 20x more out of that degree from Vell than I did sitting in those uni lectures. So I really appreciate you coming on again, Vell, and we'll do this again soon.