Revenue and COGS build
Hi guys,
Long time lurker here - thanks for the invaluable resources.
I have a question of my own now regarding Revenue and COGS build within PE-projections: the majority of models I've seen work from a bottom-up build projecting Revenues as # Units sold x Average Selling Price, and this goes for all different segments in the business. My question is: do PE funds really use such a simple model to build revenues? Do they not go into more granular levels of the drivers? And if so, where can I find more about the different drivers in industries?
Adding to this, how PE funds "build" COGS? Is it just different scenarios as %-age of revenues or do they go into more granular level? If more granular, then how is it built e.g. what are the drivers?
Thank you
Depending on the types of companies you're looking at, there are different drivers that drive revenue.
In the case of volume x price, you likely need to think about what is driving volume. If you're selling large ticket items, then you're likely driving volume by sales rep capacity. Sales rep capacity is then driven by productivity and quota attainment, etc. etc. For commodity goods, you're doing the same thing: volume x price. However, volume AND price may be driven by the distribution channels (geo, wholesaler, etc.)
As for COGs, in my mind it's simpler. Much harder to manipulate variables above the gross margin line and therefore it's easier to just model out assumptions. With that said, you still need to analyze what a steady state GM could look like, which can be based on a variety of factors such as industry benchmarks or process.
I think it's important to think outside of just the model. It's important to determine the factors that drive the inputs that go into the model.
Different drivers that drive cars that drive to and from places, driving on roads. Drive.. drive.. drive
Let's start with the method you're asking about: P x Q Units sold x average selling price can often be decomposed further. What determines the units sold? Depends on certain assumptions: are you capacity constrained or demand constrained? Where in the value chain are the capacity constraints? As for pricing, you can build an entirely new set of scenarios on top of that as well. Are you pricing to a premium or at a discount to where you are today, etc.? Is there a mix shift that could move the average price up or down (such as selling more high-end cars vs. lower-end cars). Get granular.
Depending on where the unknowns are and what the ultimate impact is to your analysis, you can do a separate build both for units and pricing. Which units you choose to forecast is also an important question: maybe it's square feet for a real estate firm and possibly retail, maybe it's a discrete unit in manufacturing or software, maybe it's seats for an airline, maybe it's viewing hours for a media or tech firm, etc. There could be utilization assumptions you need to think about throughout the delivery chain. And just as I said there could be supply constraints to think about, there may also be demand constraints: how much spend is there that you can go after, and how does that share of spend change with time?
There are other approaches as well: for example, market share capture. Maybe a TAM is $10, and you think you can capture an additional $.50. Maybe there's a way to unlock incremental spending within that new market share. Stuff like that.
COGS yes, you may be able to make more stable assumptions, but remember the value chain assumptions above. Different channels or new production lines may bring different cost assumptions. Maybe you want to lay out scenarios for materials or labor costs.
Cheers computer.
So the supply constraints are more or less related to utilisation/capacity? For simplicity, a restaurang supply constraint would be the number of chairs available inside the restaurant etc. (capacity)?
I have been trying to think about a foodservice wholesaler and how i would model its revenues. How should i think about the supply constraints there? they have effectively no supply constraints unless there is something impacting crops etc. And what would be an example of a demand constraint for a food wholesaler? When you say demand constraint is "how much you can go after" - thats more or less total market and your assumption on how much market share you can capture?
I got the pricing part, that was perfect. If it depends on the sales mix and margins, thats probably where channel checks would come in, no?
You’ll want to structure the revenue and cost builds around what you think will be the space for future questions. Just to be clear, supply vs demand constraints is are modeling choices you may want to choose to work off of. For your example, perhaps the wholesaler’s delivery trucks are 95% full. Would adding more trucks on its own mean more revenue? Probably not.
In this case, I might work off demand constraint assumptions: how many clients of different sizes, average order size, etc. Alternatively, how much do your customers spend in on supplies in general and what’s your share of their wallet (which gives you an opportunity to layer in additional analyses around how to grow share of wallet, how to find which customers spend more, etc.).
Another advantage to this approach is you can map it straight to cost of sales: for each account, there might be a delivery cost, a selling and account management cost, and then cost of goods sold. That let’s you back into analyses around new clients, shifting share of wallet and moving into higher margin items. There are more nuances, but you get the idea.
At that point, you’ve probably 95% solved for the EBITDA contribution for each unit of activity, and you’ve brought the analysis down to the account level.
Nice if you’ve got that kind of data and the time to do that kind of diligence.
Cheers computer, really helpful. I'll try to model around that and see where I arrive
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